Slovenia could be the next domino to fall in Europe
"Banks are under severe distress," the International Monetary Fund said in its annual health check on the country. Non-performing loans of Slovenia's three largest banks reached 20.5 per cent last year, with a third of all corporate loans turning bad.
Yields on two-year debt have tripled over the past week, jumping from 1.2 per cent to 4.26 per cent before falling back slightly on Thursday. Ten-year yields have reached a high of 6.25 per cent since the country joined the European Monetary Union.
"The country has lost competitiveness since joining the euro and it is leading to slow economic collapse. Markets have been very complacent, but it has been clear for a long time that the banks need recapitalisation, and it is not easy to raise money in this climate," said Lars Christensen from Danske Bank.
The IMF expects the economy to contract by 2 per cent this year, following a fall of 2.3 per cent last year. "A negative loop between financial distress, fiscal consolidation and weak corporate balance sheets is prolonging the recession. A credible plan to address these issues is essential to restore confidence and access markets," it said.
New prime minister Alenka Bratusek told the Slovene parliament on Wednesday that the fears are overblown. "Our banking system is stable and safe. Comparisons with Cyprus aren't valid. Deposits are safe and the government is guaranteeing them."
Slovenia's bank assets equal 130 per cent of GDP compared with 700 per cent for Cyprus, though the Cypriot figure is misleading since a large part of its banking system is made of "brass plate" subsidiaries of foreign lenders such as Barclays or Russia's VTB.
Tim Ash from Standard Bank said the events of the past two weeks had pushed the country over the edge. "Slovenia is now inevitably heading towards a bailout. The eurozone shot itself completely in the foot in Cyprus," he said.
The Slav-speaking state - a Baroque jewel with historic ties to Austria - has a population of just 2 million and is too small to pose a financial threat.
However, analysts say a crisis in Slovenia would further complicate EMU politics, forcing the northern creditor states to define their rescue strategy yet again. Austerity fatigue in Germany and the Netherlands has already caused policy to harden.
Luxembourg has also come into focus as markets take a closer look at EMU money centres. Its banking assets are 2500 per cent of GDP, by far the highest in the eurozone.
Eurogroup chief Jeroen Dijsselbloem fanned the flames in an interview this week, advising Luxembourg to cut leverage in its financial system and trim its banks. "Deal with it before you get into trouble," he said.
The comments caused fury in the Grand Duchy. "We do not attract Russian money to Luxembourg with high interest rates. The Luxembourg financial centre is based on several pillars, we are characterised by the breadth of our product range," said Premier Jean-Claude Juncker.
The knock-on effects in Portugal, Spain and Italy have so far been mild, though bond spreads have climbed to three-month highs.
"It's remarkable how little contagion there has been, since capital controls and major depositor haircuts violate fundamental principles. The assumption has always been that this would be game over," said Julian Callow, the chief global economist at Barclays.
Moody's warned that the erratic handling of Cyprus had "significantly heightened fears surrounding the safety of bank deposits in other European systems", and left Portugal vulnerable to renewed stress.
Italy faces its own crisis after last-ditch efforts to form a government collapsed on Thursday night, raising the likelihood of a caretaker leader and fresh elections.
Mr Callow said it was hard to see Italy could comply with the strict terms of an EMU bailout, which in turn leaves it unclear whether the European Central Bank's back-stop for Italian debt is still valid.
"The eurozone is running out of time," he said. "If there is no growth for another year, and unemployment ratchets higher, citizens are going to turn against the euro."
Frequently Asked Questions about this Article…
Slovenia's borrowing costs rose sharply after investor worries about a banking and fiscal crisis. Two-year yields tripled in a week (from about 1.2% to around 4.26% before easing) and ten-year yields hit as high as 6.25% since joining the euro. The spike followed concerns about bank distress, high non-performing loans and contagion fears after the Cyprus episode.
The International Monetary Fund flagged severe distress in Slovenian banks: non-performing loans at the country's three largest banks reached 20.5% last year, and about a third of corporate loans had turned bad. For investors, high non-performing loans signal weaker bank balance sheets, higher potential losses and greater risk of prolonged recession or government intervention.
Some analysts in the article, including Tim Ash from Standard Bank, say Slovenia is 'inevitably heading towards a bailout' given the recent market pressure. However, Slovenian prime minister Alenka Bratušek insisted the banking system is 'stable and safe' and that deposits are guaranteed. The situation remains debated and depends on recapitalisation options and policy responses.
The IMF expects Slovenia's economy to contract by 2% this year after a 2.3% fall last year. The IMF warned a negative loop between financial distress, fiscal consolidation and weak corporate balance sheets is prolonging the recession. For investors, shrinking GDP raises credit risk, increases sovereign borrowing costs and can suppress corporate earnings across affected sectors.
Slovenia's bank assets equal about 130% of GDP, versus roughly 700% for Cyprus and about 2500% for Luxembourg. The article notes the Cypriot figure can be misleading because much of its banking system consists of 'brass plate' subsidiaries of foreign lenders such as Barclays and Russia's VTB. Luxembourg's large banking sector has also come under scrutiny for high leverage.
The article describes contagion risks: bond spreads in Portugal, Spain and Italy climbed to three‑month highs, and Moody's warned that Cyprus's handling of its crisis heightened fears about deposit safety elsewhere in Europe. Analysts say a Slovenian crisis would complicate EMU politics and force northern creditor states to revisit rescue strategy.
Political uncertainty in Italy — where efforts to form a government collapsed, prompting the prospect of a caretaker leader and fresh elections — was highlighted as increasing risk. Analysts noted that strained politics and weak growth could undermine the European Central Bank's back‑stop credibility and raise doubts about compliance with strict bailout terms.
Investors should monitor sovereign and bank bond yields and spreads, official statements from the IMF and Slovenian government about recapitalisation or guarantees, any eurogroup or ECB guidance on support, and political developments in Slovenia and larger eurozone economies. These factors will influence market confidence, deposit safety perceptions and the likelihood of broader contagion.
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