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Republic of Serbia: 2013 Article IV Consultation

International Monetary Fund. European Dept.
Published Date:
July 2013
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Macro-Financial Linkages1

Credit growth is important for economic activity in Serbia. Yet, the current credit growth rate is lower than during the onset of the global financial crisis—this is likely to make durable economic recovery challenging. The slowdown of credit is indicative of the broader challenges faced by the economy, such as domestic and external vulnerabilities, elevated level of uncertainty and an underdeveloped export-oriented private sector. In turn, these challenges increase lending risk and suppress both demand for and supply of credit. The buffers accumulated by the banking sector before the beginning of the global crisis helped maintain stability of the banking system, but the system is facing a number of challenges such as significant level of nonperforming loans (NPLs) and exceptionally high euroization. Reducing macroeconomic vulnerabilities and addressing high level of NPLs would decrease the perceived level of risk and facilitate financial intermediation.

A. Low Credit Growth: a Consequence of Weak Demand or a Driving Force of Economic Slowdown?

1. Credit to Serbia’s private sector is weak, although its dynamics are still more favorable than in peer countries. Credit from both the domestic banking system and the external sources is no longer growing in the nominal terms and declining in the real terms. Cross-border credit is being unwound, implying that Serbia’s enterprises need to find access to alternative sources of financing (Figure 1). After some recovery in 2009–10, domestic credit has been decelerating—its current growth rate is lower than during the onset of the global financial crisis.2 In real terms (nominal credit in local currency at current exchange rates adjusted for CPI inflation) Serbia’s domestic credit has been declining, although more slowly than in several New Member States of the EU (NMS). Credit growth continued to decelerate in late 2012 and 2013:Q1 despite the authorities’ attempts to boost it via a subsidized credit program—a significant share of loans extended under this program went to refinancing of old loans rather than new financing.

2. Domestic credit is crucial for Serbia’s economic activity. There is a positive correlation between credit—and particularly domestic credit—and GDP growth (Figure 1). Bank credit is important for financing investment as non-bank financing channels (capital and securities markets) are not well-developed in Serbia. Credit is also important for financing housing construction and consumption of durables. Thus, low private sector credit growth may pose a drag on investment and consumption and therefore on economic recovery.

Figure 1.Serbia: Credit Growth Indicators, 2004-13

Sources: NBS, IFS and Fund staff calculations

1/ Measured as nominal credit at current exchange rates adjusted for headline CPI inflation.

3. An important question is to what extent the slowdown in domestic credit has been driven by supply-side restrictions as opposed to weak demand for credit. Conceptually, the supply factors are those that determine the interest rate offered by a bank to a borrower for a given level of credit: they include availability and cost of funding (both domestic and external), lending standards as well as premia that compensate banks for lending risks. The demand for credit depends on the availability of projects in which the expected rate of return is higher than the interest rate—this, in turn, depends on (i) the cyclical position of the economy (as demand for credit is lower during recessions due to weaker economic activity), and (ii) fundamental characteristics of the economy (technology, intertemporal discount factor in the utility function, etc.). In a purely demand-driven credit slowdown, a reduction in credit growth is a consequence of low aggregate demand and therefore demand-stimulating policies should help restore it. On the contrary, a supply-driven credit shock can be contributing factor to—rather than a consequence of—a slowdown of the broader economy calling for policies addressing credit supply issues.

4. In practice, however, disentangling demand and supply factors is challenging. To overcome the difficulty, the literature resorted to the analysis of lending surveys that convey views of senior bank credit officers regarding lending conditions. One example is the Bank Lending Survey for the Euro Area (BLS) which poses questions regarding perceptions of changes in credit standards as well as terms and conditions of lending in the past three months (Berg et al., 2005).3 The studies based on these surveys typically find that even after controlling for loan demand, supply-side constraints negatively affect credit (Hempell and Sorensen, 2010). In Serbia, however, a lending survey is not available and the analysis of relative importance of supply and demand factors needs to rely on the observed data.

5. Serbia’s credit market outcomes suggest that both supply and demand factors played an important role in credit slowdown since the beginning of the crisis in 2008. Whereas annual credit growth changed significantly (from about 30 percent before the crisis to low single digits at end-2012), the lending interest rates fluctuated within a narrow band of 7–9 percent, showing considerably less variation than in the euro area. This is consistent with a hypothesis that both supply and demand schedules shifted simultaneously in the way that produced large changes of credit volumes without much change in the interest rates. Demand for credit was affected by a slowdown in economic activity. Supply of credit was restricted by availability and cost of funding as well as tightening of the lending standards associated with rising perception of risk as discussed in more detail below.

The relative stability of the FX interest rates…

Sources: NBS and Fund staff calculations

…is consistent with shifts in both demand and supply of credit.

6. Availability of funding declined and its cost increased since 2008. Domestic deposits and foreign liabilities constitute the bulk Serbia’s bank funding sources, and both of these slowed down significantly after the onset of the crisis. Deposits contracted in the beginning of 2009 and, after a period of recovery in late 2009–early 2010, began to slow down again (Figure 2). Foreign funding—measured as gross foreign liabilities in the monetary survey—picked up in 2009 but plateaued afterwards. Relative importance of various factors could be illustrated by a decomposition of the period average credit growth rate into contributions of major bank survey aggregates (i.e. deposits, net foreign assets, net claims on government, net claims on NBS, and net other items).4 In 2008, credit was propelled mainly by deposit growth (blue bars). In later years, the contribution of domestic deposits has been reduced and, moreover, credit has been consistently crowded out by the increases in net claims on government (red bars). Relatively high price of funding contributed to the high lending interest rates. The price of funding, in turn, is correlated with the external risk premium.

Contributions to period average credit growth at constant exchange rate


Sources: NBS and IMF staff calculations.

Figure 2.Serbia: Supply-side Factors of Credit, 2006–13

Source: NBS, IFS and IMF staff calculations.

1/ Nominal interest rates on loans in local currency adjusted for CPI inflation.

2/ Interest rate on FX loans to non-financial corporations.

3/ Nominal interest rates on household deposits in local currency adjusted for CPI inflation.

External risk premium and lending interest rates in the real terms, 2012

Sources: NBS, IFS and Bloomberg

7. Since the beginning of the crisis, perception of risks increased and the lending standards tightened. Difficult external financing environment as well as domestic macroeconomic vulnerabilities—such as volatile inflation, large twin deficits and the weak real sector—increased banks’ lending risk, which led to tightening of credit standards. The large stock of nonperforming assets and the associated need for provisioning eroded profitability, raising lending margins. In the absence of a lending survey, overall perception of risk could be approximated by a financial stress index. The financial stress index (FSIX) aggregates information about exchange rate and stock market volatility, as well as spreads of the interbank rate and government bond over the NBS’s policy rate (Box 1 elaborates on the construction of the FSIX). As expected, credit growth is correlated with the inverse of FSIX. Two periods of financial stress buildup (2009 and 2011) were associated with the slowdown of credit growth. Interestingly, the FSIX has been declining since 2012:Q3 (on account of lower volatility of the exchange rate and stock market index, declining yields on sovereign debt) but credit growth was still slowing down.

Domestic credit growth and the financial stress index

Sources: NBS and IMF staff estimations.

Box 1.Construction of a Financial Stress Index (FSIX)

The health of the financial sector can affect economic activity through various channels. As it is difficult to attribute the well-functioning of the financial sector to a single indicator, FSIX is constructed to capture the functioning of these channels. FSIX is a composite index including deviations of the four following components from their average values: (i) spread of the interbank money market rate (BEONIA) over the NBS policy rate, (ii) stock market volatility, (iii) exchange rate (ER) volatility, and (iv) government borrowing spread over the NBS policy rate. Positive values of this indicator imply higher-than-average levels of financial stress in the market and negative values indicate less-than-average stress levels.

Financial Stress Index and GDP Growth 1/

Sources: NBS and IMF staff calculations.

1/ Higher values of index indicate higher levels of stress.

8. There is anecdotal evidence that in the recent quarters low demand for credit plays more prominent role than supply-side factors. Banks generally report that there are no applications for credit—this is confirmed by the fact that the excess liquidity in the system does not translate into new loans. Given that lending interest rates do not appear to adjust downwards to account for the excess supply, this suggests either a disequilibrium condition in the credit market or implicit presence of supply-side restriction that does not allow a downward adjustment of the interest rates.

B. Changing Banks’ Business Models and External Deleveraging: How Did It Affect Serbia’s Economy?

9. Business models of European banks are changing, which has implications for countries that host subsidiaries of these banks. Before the beginning of the global financial crisis, subsidiaries in host countries relied extensively on external source of funds, including parent banks’ funding. This increased loans-to-deposit ratios in some countries to very high levels. Since the onset of the crisis, banks began to re-orient their funding sources towards local deposits, implying the need for external deleveraging and downsizing of assets.

Loan to deposit ratio, 2008-2012Q3

(private sector credit as a percentage of private sector deposits)

Sources: IFS and IMF staff calculations.

10. In order to examine the impact on Serbia, it is useful to delineate various financial linkages as outlined in the diagram below. Foreign parent banks provide financing to Serbia’s subsidiaries (link “bank-bank” (BB)) as well as direct financing of Serbia’s corporates (link “bank-corporate” (BC)). These links can be examined using BIS data (with a caveat that BIS dataset does not include a number of foreign banks (e.g., Russian banks) that could also provide financing to Serbia. Besides banks, other foreign sectors (i.e., multilaterals) are an important source of financing for the Serbia’s non-government sector. They are represented by links “OB” (e.g., credit from multilaterals to Serbia’s banks) and “OC” (e.g., intercompany credit). Whereas many links are essentially one-way (e.g., link OC), others are bi-directional (e.g., Serbia’s banks are financed by parent banks but also hold claims against foreign parent banks) and it is useful to analyze them on both gross and net basis.

11. Monetary and external debt data suggest that while Serbia’s enterprises were affected by deleveraging, foreign liabilities of Serbia’s banks remained broadly stable. Banking survey data show that the total foreign liabilities of Serbia’s banks (other than shares)—which are represented by a sum of links BB and OB in a diagram below—increased in 2009 and have been marginally unwinding since then. Viewed on a net basis (a negative of net foreign assets of commercial banks), foreign liabilities of Serbia’s banks have been oscillating around a broadly stable level.

Gross foreign liabilities of Serbian banks

(billions of Euros)

Net foreign liabilities of Serbian banks

(billions of Euros)

Sources: NBS and BIS.

1/ BIS data on net exposure includes FX reserves of the cetral bank into assets.

12. Taking end-2008 as a reference point, BIS locational banking statistics suggest that deleveraging in Serbia compares relatively favorably to that of Serbia’s European peers. Whereas the reduction in gross external claims in many countries was substantial, overall claims on Serbia declined only marginally (they actually increased for Serbia’s banks). This is consistent with better credit growth outcomes in Serbia relative to these in countries where deleveraging has been more pronounced. However, the BIS data suggest considerable reduction of claims on Serbia’s banks—in both gross and net terms—in 2012 (Figure 3). This could be partly explained by claims of foreign banks or entities that do not report to BIS.

Change in exposure of BIS-reporting banks between Q4 2008 and Q3 2012

(percent of GDP)

Source: BIS

Figure 3.Serbia: Exposure of BIS Reporting Banks to Serbia, 2006–2012Q3

Source: BIS Locational Banking Statistics Database.

1/ BIS data on net exposure includes FX reserves of the cetral bank into assets.

C. How is Serbia’s Banking System Coping with the Macroeconomic Strains?

13. Buffers of Serbia’s banking system helped to preserve its stability during the crisis. At the outset of the crisis, Serbia’s banking system had one of the highest capitalization rates in among the peer countries and the very high level of provisioning (Figure 4). NPLs were substantial but also well-provisioned. Since 2008, the capitalization declined (also partly due to introduction of the Basel II supervisory standard at end-2011), but it remained substantially higher the regulatory minimum and still stronger than in many peers. The NPL ratio rose to nearly 20 percent, but the increase was smaller than in some of the peer group countries. The level of provisioning declined but remains one of the highest in Emerging Europe. The level of banking system liquidity is adequate, and the banking system—excluding a few exceptional cases that needed resolution—is still profitable.

Figure 4.Serbia: Selected Financial Soundness Indicators, 2012 1/

Sources: National Bank of Serbia, IMF

1/ Data for Albania and Montenegro are as of end-2011, and for Latvia as of March 2012.

2/ Profitability indicators for Serbia in 2012 are affected by the outliers (Agrobanka, New Agrobanka and RBV that have been resolved).

14. Despite stability, the banking system is facing challenges. Current macroeconomic environment—including anemic economic activity in the environment of strained balance sheets—increases the risk of non-payments and further rise of NPLs. Exceptionally high euroization of the lending portfolio is the Achilles’ heel of the banking system: many borrowers are unhedged and therefore are subject to a significant exchange rate risk, implying credit risk for the banks.

Loan Euroization, September 2012

(by exchange rate regime; Percent)

Sources: IFS, FSI, National Bank of Serbia and NBRM.

Deposit Euroization, September 2012

(by exchange rate regime; Percent)

D. Policy Implications

15. As bank credit is the most important financing channel for Serbia’s private sector, reviving credit growth to a healthy level would be instrumental for supporting the revival of the economy. Low credit growth could create a drag on economic activity and obstruct realizing Serbia’s potential.

16. Reviving bank lending, however, may be difficult to achieve without addressing the broader challenges in Serbia’s economy. The first challenge is to reduce macroeconomic vulnerabilities—maintaining macroeconomic stability would alleviate some of the most serious supply-side limitations: it would reduce banks’ perceptions of lending risks, possibly improve banks’ external financing terms and reduce crowding out of private investment. It could also improve trust in the financial system and therefore improve prospects for channeling their savings to banks as opposed to “mattress money.” The second broad challenge is to finish the structural reforms that would support development of private sector and increase return on investment in Serbia—this would increase demand for credit. These are, however, policies that apply to all sectors in Serbia and must be considered in the “general equilibrium” sense.

17. In addition, addressing supply-side credit restrictions specific to Serbia’s financial sector would help restore credit growth. The high level of bank lending interest rates in Serbia is indicative of the structural bottlenecks in the credit channels. The following measures could be considered:

  • Addressing the high stock of nonperforming loans would improve banks’ balance sheets and reduce costs of dealing with NPLs. This could reduce banks’ margins and therefore increase supply of credit. Specific measures could include fostering of out-of-court debt workouts and clarifying creditor classes in bankruptcy procedures and creditor rights under the mortgage law.
  • Implementing the strategy of dinarization would reduce credit risk stemming from non-hedged borrowers. This should include deepening local currency financial markets and fostering development of institutions that operate in these markets (pension funds, insurance companies, etc.).
  • Avoiding significant relaxation of tight prudential policies. Whereas Serbia’s tight regulatory policies probably added to the cost of credit (e.g., the required level of provisioning is one of the highest in Europe), safety cushions built as a result of these policies could be vital in the case of financial stress.

    Berg, Jesper, Adrianvan Rixtel, AnnalisaFerrando, Gabede Bondt and SilviaScopel,2005, “The Bank lending Survey for the Euro Area” ECB Occasional Paper Series, No. 23/February 2005. Available from:

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    DelGiovane, GinetteEramo and AndreaNobili,2010, “Disentangling demand and supply in credit developments: a survey-based analysis for Italy.”Bank of Italy’s Working paper, Number 764.

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    Hempell, Hannah Sabine and Christopher KokSorensen,2010“The Impact of Supply Constraints on Bank Lending in the Euro Area: Crisis Induced Crunching?”ECB Working Paper No 1262. Available from:

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Prepared by Dmitriy Kovtun and Eugen Tereanu (EUR)


There is a structural break in the domestic credit time series in October 2012 due to the resolution of Nova Agrobanka (as assets in banks undergoing bankruptcy are removed from the monetary survey). The effect amounts to some 2½ percent of the total credit stock.


BLS defined credit standards as internal guidelines or criteria—written or unwritten—which reflect a bank’s loan policy. BLS posed questions how credit standards are affected by the following factors: (i) cost of funds and balance sheet constraints (costs related to bank’s capital position, ability to access market financing, liquidity position), (ii) pressure from competition, and (iii) perception of risk.


Decomposing the growth rate of period averages—as opposed to end-of-period stocks—is better for this purpose as it helps reduce the base effects and the noise in the data.

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