Financial Crime World

Croatia’s Financial Markets Face Turbulence

The financial markets of Croatia are facing significant challenges, including a sharp increase in the Emerging Market Bond Index (EMBI) and widening credit default swap spreads. These developments have raised concerns about the country’s external vulnerabilities.

According to figures released by Bloomberg and J.P. Morgan, Croatia’s Overnight Money Market Interbank Deposit Rate and Spot Exchange Rate against the Euro have been fluctuating over the past year. The Croatia Stock Market Index (CRO Index) has also seen a decline, while government bond spreads remain high.

Household Debt Concerns

The ratio of Croatian household debt to GDP continues to grow, raising macroeconomic concerns. As of September 2007, household debt stood at over 40% of GDP, one of the highest in central and eastern Europe. The share of bank lending to households has increased significantly from around 33% of total loans in 1998 to 55% in 2005.

  • Key concerns:
    • Rising household debt ratio increases vulnerability of banks to deterioration in debt servicing capacity
    • High proportion of loans are FX-linked, exposing banks to indirect FX risk
    • Most loans are issued at floating rates linked to local or euro-area interbank market rates, subjecting banks to credit risk through customers’ interest rate exposure

Corporate Debt and Deregulation

The debt burden of non-financial corporations is also growing rapidly, totaling 59% of GDP in 2006. Debt owed to banks dominates the non-financial corporate debt structure, with a significant proportion of loans being FX-linked.

  • Key concerns:
    • Rapid expansion of FX-linked loans to unhedged borrowers in 2005-06
    • Lengthening of mortgage maturities raises concerns about banks’ ability to manage risk
    • Deregulation and strong competition have led to banks lowering their underwriting standards

Conclusion

Croatia’s financial markets are facing significant challenges, including high household debt, growing corporate debt, and deregulation leading to weaker underwriting standards. These factors increase the vulnerability of banks to a deterioration in debt servicing capacity and credit risk exposure.

To stabilize the financial system and ensure long-term economic growth, policymakers must address these concerns and implement measures to mitigate the risks associated with high household debt, rapid expansion of FX-linked loans, and deregulation.