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EXECUTIVE SUMMARY

The Slovak financial sector has been growing rapidly as the depth of financial intermediation trends towards developed country norms following the bank restructuring and privatization program of the early 2000s. Commercial banks are by far the dominant financial institutions, though non-bank financial institutions have grown faster than the banks in recent years, and the securities markets remain small.

Financial soundness indicators (FSIs) present a picture of a robust banking system. Capital adequacy ratios (CARs) have been falling—which is to be expected given their relatively high levels following the reforms—but they are still at healthy levels. Increased competition in the banking sector has contributed to improved access to credit for households and SMEs, and also to reduced interest rate spreads and banks’ fee levels. So far at least, the increased competition has not led to any significant lowering of credit standards.

Although rapid, the rate of bank credit growth seems appropriate, given the strong outlook for the economy. Furthermore, in contrast to some neighboring countries, lending is predominantly in local currency, so that banks are not exposed to indirect foreign currency risk. Nevertheless, banking system fragilities could appear in future if the rapid rate of credit growth continues for an extended period. The supervisory framework currently appears to be adequate to identify and monitor any risks that do arise from this source.

Stress tests confirm that the banks are currently resilient to a range of possible adverse shocks. Reflecting the current healthy capital position of the banking system, none of the sensitivity and scenario stress tests considered would bring the average Tier I capital adequacy of the system below 10 percent.

While the performance of the insurance sector has been good overall, the level of technical provisions for part of the life insurance industry is relatively low. In particular, technical provisions for many older life policies with guaranteed capital need to be increased, to reflect that interest rates have fallen further than was assumed at the time they were written. There is also a need for the supervisor to monitor the capital adequacy on life insurance policies closely. Relatedly, the highly competitive market for motor third party liability (MTPL) insurance is limiting companies’ ability to raise premia in that sector, which will also require close monitoring.

A new multi-pillar pension system was introduced in 2005, aimed at making the Slovak social security system sustainable, but some challenges remain. Investment returns for pillar 2 pension funds have been low to date, and actions may be needed to encourage higher returns through greater diversification. Changes in the regulations covering governance and competition would also facilitate higher returns. The Government should also consider starting preparations for the payout phase of the pension system.

The securities markets in Slovakia are small and illiquid. As integration with the EU deepens, corporate entities in Slovakia will be able to access markets in Western Europe with

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