University in Sarajevo

School of Economics and Business

Topical area:

EFFECTS OF GLOBAL FINANCIAL CRISIS IN THE BANKING

SECTOR OF BOSNIA AND HERZEGOVINA

Mentor: Professor Karamuji Muharem, PhD

Students: Kerim Bjelak 71902

Roman Liina 71250

Sarajevo,January 2017

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Abstract

Throughout the history many financial crises have occurred. Sometimes they would have effects
on entire planet, and sometimes they would encompass different parts of the world. Global
Financial crisis is manifested on developed and developing country through decrease in GDP,
increase in unemployment and slower economic growth. We could have witnessed the big global
financial crisis 2007/2009 which had devastating effects all over the world, and we can say that
this crisis had different effects on different countries. Even though Bosnian and Herzegovinian
banks did not participate in the US mortgage market, nor did invest into mortgage-backed
securities, the negative effects of the financial crisis didnt bypassed our country like many
analysts thought in the beginning.

The aim of this research paper is to show how devastating effects this financial crisis had on our
country, and we will focus on the Banking system of the Bosnia and Herzegovina. To be more
precise we will talk about crisis effects on bank profitability and increase of non-performing
loans.

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 CONTENT

INTRODUTION...............................................................................................................................4

HYPOTHESIS..................................................................................................................................5

METHODOLOGY...........................................................................................................................6

HISTORICAL REVIEW OF FINANCIAL CRISIS 2007/2009......................................................7

ANALYSIS.......................................................................................................................................8

Amount of total loans...................................................................................................................8

Movement of interest rates in banking sector of B&H.................................................................9

Profitability of banking sector in B&H......................................................................................11

CONCLUSION..............................................................................................................................13

REFERENCES...............................................................................................................................14

TABLE OF FIGURES

Figure 1: Total Loans in Banking sector for period 2008-2013

Figure 2 Movement of active interest rates in banking sector of B&H 2008-2013
Figure 3 Banking sector profitability for period 2007-2013

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 INTRODUTION

In order to create a positive environment for development of economy, every government should
make its contribution. Financial crisis 2007/2009 hit the most developed countries in the world
and affected their economies a lot. Collapse of the mortgage market caused the so called great
financial crisis and in a short period of time it spread across the world and Bosnia and
Herzegovina wasnt exception. What becomes clear is that the mortgage industry had become a
system that linked all of the financial institutions in the economy and made them dependent on
the continued increase in U.S. housing prices."1

In this research paper we wanted to make a link between one of the biggest, if not the biggest
financial crisis and its effects in our country so that is the reason why we choose Effects of
global financial crisis in the banking sector of Bosnia and Herzegovina as our topical area.

We wanted to make our topical area narrow as much as possible and to prove our hypothesis
through different aspects of banking system and its examples. Our country felt indirect effects of
the crisis and the reason for indirect and not direct effects lies in the fact that our commercial
banks were not exposed to markets which were already hit by the crisis (e.g mortgage market in
the USA). However, even though our country didnt experience the effects of the crisis
immediately, after a certain period of time we could see the negative changes in financial and
therefore banking sector of Bosnia and Herzegovina.

Banking sector is the sector of the economy devoted to the holding of financial assets ad
investing those financial assets as leverage to create more wealth.

Stagnation and fall of economic activity caused increase of unemployment and decrease in
investments, and when it comes to banking sector, it caused decrease in credit activity and
increase of interest rates. Due to increase of unemployment, the amount of non-repaid loans

1 Grusky, David B., Western, Bruce, and Wimer, Christopher, eds. The Great Recession. New York, US: Russell
Sage Foundation, 2011. ProQuest ebrary. Web. 5 October 2016.

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increased and the banks faced with a problem. In further research paper, we will analyze how the
financial crisis affected profitability of banking sector in Bosnia and Herzegovina.

HYPOTHESIS

Financial crisis 2007/2009 had negative effects on banking sector in Bosnia and Herzegovina.

Description of the hypothesis:

The global financial crisis has shown that the principle of reasonable funding wasnt developed
enough by the banks. Deterioration of business conditions and decline of general population
standard as a result of economic crisis led to significant increase in non-performing loans that
caused deterioration in asset quality. Due to increase in interest rates, credit activities of banks
decreased, meaning that getting a loan from a bank is much harder. Stability of banks in Bosnia
and Herzegovina was secured with high liquidity reserves 2. According to Muris eerkadi,
banks in Bosnia and Herzegovina didnt have problem in setting its obligations towards
depositors, because they operated purely as commercial banks and have good portfolio. Since the
most parent banks are regional and did not participate in international financial market, neither
did Bosnian banks invest into risky markets. Consequences of the crisis in the Bosnia and
Herzegovina were reflected through increase in interest rate, and given the fact that there were
less free funds in the world money market.

Mass panic among citizens of B&H led to high deposit withdraw from their banks and the reason
for mass withdraw of funds is lack of trust in financial and banking system of Bosnia and
Herzegovina.

Hypothesis aims to explain relationship between Global financial crisis and its effects on banking
sector of Bosnia and Herzegovina.

2 Muris eerkadi, (2009); Banking agency of the Federation of Bosnia and Herzegovina.

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 METHODOLOGY

Due to complexity of our topical area and with the aim of getting concrete results, we used both
theoretical and quantitative approach. Relevant data we used was consisted mostly out of
secondary data (published by the Central Bank of Bosnia and Herzegovina, Banking agency of
the Federation of Bosnia and Herzegovina etc.), different published literature, economic articles
related to the topic etc.

Since our topical area is related to financial crisis and banking system of B&H, we had to
conduct a theoretical research in order to propose a hypothesis and to make a short introduction
for our research paper. In order to understand the effects of financial crisis on banking sector of
Bosnia and Herzegovina, we had to make a little theoretical review of how the crisis occurred in
the first place. After the theoretical explanation of occurrence of financial crisis we will try to
prove our hypothesis by analyzing various aspects of banking sector such as: profitability of
banks, movement of interest rates in the banking sector, credit activity.

To confirm the validity of our hypothesis, we had to focus on statistical data and information
manifesting them throughout the graphs and tables but we also used articles written by Kemal
Kozari, former Governer of the Central Bank of Bosnia and Herzegovina in order to clarify
situation of banking sector in B&H during the crisis.

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 HISTORICAL REVIEW OF FINANCIAL CRISIS
2007/2009

In the period of 1997-2006 prices of houses in the US increased for 124% and due to this
increase, banks were approving prime-mortgage loans. This is type of loan where bank gives a
loan to a borrower who pays certain principal and interest and if the borrower cant repay the
loan, bank takes his house because it was the collateral for coverage of issued loan. Since there
were many people who were taking mortgage loans, bankers saw the opportunity of conducting
securitization of those mortgage loans and sell them to investors on secondary market and gain
even more profit. Securitization is a process of taking an illiquid asset and transforming it into
marketable security through the financial engineering. The problem was not in prime mortgage
loans, the problem starts with approving sub-prime mortgage loans which were given to the
people with bad or unknown credit history, but the bankers didnt care because they expected
constant growth house prices and in the case of non-repayment, they would simply take the
house. In 2003-2004 FED decreases reference rate to 1%, meaning that banks can get cheap
money from fed and issue more mortgage loans with lower interest rate and securitize them. But
after a certain period of time, FED increased reference rate and commercial banks had to increase
their interest rate which led to situation where many people who got sub-prime mortgage loan
could not repay the debt, so they have to give up their homes in order to cover the debt but
suddenly excess of supply of houses appeared in the market and the house prices started
decreasing significantly. These houses could not cover entire debt and banks suffered great losses
which led to bankruptcy of many large banks. This caused mortgage-market failure which was
just one of the dominos that caused global financial crisis 2007/2009. Since many banks could
not cover their debts, they declared bankruptcy which created mass panic and huge deposit
withdraws from banks due to lack of trust in banking sector.

Many investment banks were present on the US mortgage market, and many of them were
trading with mortgage-backed securities, but with the collapse of mortgage market, European and
Asian banks had big losses as well, and that was actually how the global financial crisis started

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8
 ANALYSIS

Amount of total loans

Banks perform the function of mobilization and concentration of financial resources in the
economy and its conversion into loan3. The credit function is one of the basic functions of banks'
operations, and therefore the level of total loans is the most important indicator of the volume of
business of banks, but also the greatest generator of potential risk. Although the main cause of the
global financial crisis are credits, banking sector of Bosnia and Herzegovina successfully cope
with the effects of global crisis due to good capitalization.

Figure 1: Total Loans in Banking sector for period 2008-2013 (in billions of KM)

16,000.00

15,500.00

15,000.00

14,500.00

14,000.00

13,500.00

13,000.00

12,500.00

12,000.00
12/2008 12/2009 12/2010 12/2011 12/2012 12/2013

Source: Central Bank of Bosnia and Herzegovina (www.cbbh.ba)

3 Komazec & Risti, 2012; Berzanski i bankarski menadzment

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Amount of total loans in 2009. was 13,68 billion which was lower than the amount in previous
year when total loans were 14,13 billion. In that period, due to beginning of financial crisis in
B&H, consumption and volume of activities of domestic companies decreased which affected
demand for new loans and at the same time commercial banks imposed more strict credit request
and interest rate increased. We can see that negative factors of the crisis occur in the Bosnia and
Herzegovina and it can be concluded on the basis of new loans issued to private non-financial
companies that have increased in comparison with 2009. As we can see furthermore, in 2011
credit activiti intensified even more comparing to previous two years. This trend of credit activity
growth among commercial banks was present during the 2013. Based on the above, we can
conclude that in the observed five-year period, lending activity of commercial banks in B&H
increased. In that period, banks have implemented a restrictive policy in granting new loans, and
we can't ignore the fact that this was a period of decreased consumption and slowdown in
economic activity.

Movement of interest rates in banking sector of B&H

Interest represents a fee for the use of borrowed assets, or the cost of the current consumption.
When it comes to banks, interest can have double role:

When a bank pays interest on acquired asset (passive interest)

When bank charges interest on invested fund (active interest)

Since the profit is main goal of any business, the basic strategy of interest rate policy refers to the
achivement of largest possible positive difference between active and passive interest. Due to the
appearance of global financial crisis, there was an increase in interest rates which further
aggrevated collection of receivables from banks.

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Figure 2: Movement of active interest rates in banking sector of B&H 2008-2013

Source: Central Bank of Bosnia and Herzegovina

Short-term loans for non-financial companies

Long-term loans for households in KM indexed to EUR
Short-term loans for households in KM
Long-term loans fo non-ginancial companies in KM indexed in EUR

Since the beginning of 2009, the lending rates of commercial banks continued their upward trend,
which began in 2008 due to the instability in the financial market. In 2010, lending rates were
fluctuating but they had decreasing tendency so in the end of the year weighted average of all
lending interest rates in B&H was 8,22% which was down by 0,21% compared to previous year.
Trend of decreasing of interest rates continued throughout 2011. meaning that in the end of that
year, weighted average of all active rates was 7,54%. We can see slight descrease of interest rates
in 2013 which led to increase in credit activity.

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Profitability of banking sector in B&H

Based on the Annual Report of the CBBH, the profitability of banks in BiH was reduced in 2009,
and it is considered that this is the year in which the global financial crisis reached its peak in
BiH. In the same year, total profit after tax in the banking sector was 17,4 million which
represents a significant reduction compared with 2008 (down by 65.5 million), and the number of
banks that operate at loss was increasing.

Banking sector in 2010 was still in crisis and experienced decrease in profitability. In 2011
profitability indicators show a significant improvement compared to previous year which was
achieved by the increase in credit activity. Slight improvement in profitability was present in
2012, but the upward trend was interrupted in 2013, which ended a negative financial result.

Figure 3: Banking sector profitability for period 2007-2013

Profitability
Net interest
Y Q Return on Return on income to Non- interest
average average gross expenses to
assets equity income gross income
2007 Q4 0,8 8,6 59,7 85,1
2008 Q4 0,4 4,2 60,6 90,6
2009 Q4 0,1 0,8 61,5 97,4
2010 Q4 -0,6 -5,5 60,1 109,0
2011 Q4 0,7 5,8 63,9 86,5
2012 Q4 0,6 4,9 63,7 87,4
2013 Q4 -0,2 -1,4 62,3 101,2

Source: Central Bank of Bosnia and Herzegovina

One of the biggest problems of the banking sector in BiH are non-performing loans, whose share
in total loans has increased significantly since the outbreak of the global financial crisis. In 2009,
asset quality indicators recorded a double deterioration of its value compared to the end of 2008.
The quality of bank assets deteriorated due to the weakening of the creditworthiness of the
borrower. Most of the non-performing assets, even 98.1% are non-performing loans, ie, loans that

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have delays in repayment and negatively affect the credit portfolio of banks. The total value of
non-performing loans at the end of 2009 was 792.4 million KM and increased by 358.4 million
(54.8%) compared to 2008. Non-performing loans in total loans stood at 5.87% and higher for
2.78% compared to the previous year, when it was 3.09%. In 2011 there was an increase in non-
performing assets in the whole banking sector, and its most important part consists of non-
performing loans, whose share was around 93.6% of non-performing assets. Trend of increasing
non-performing loans continued in 2013.

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 CONCLUSION

The aim of this research was to show that Financial Crisis 2007/2009 had negative effects on
banking system of Bosnia and Herzegovina. In our research we prove that financial crisis did not
bypass banking sector of B&H.

Based on the research we conducted and data collected from the Central Bank of Bosnia and
Herzegovina we could see that global financial crisis had negative effects on banking sector in
our country. First signs of crisis in Bosnia and Herzegovina occurred in 2009, and we could see
the effects immediately. Decrease in profitability, increase of non-performing loans in total loans
is sign of financial crisis. Even though profitability indicators show improvement, the number of
bad loans is increasing. Banking sector alone cannot be sufficient for development of the
economy but the real sector is part of economy with a potential necessary for economic growth of
Bosnia and Herzegovina.

To summarize, in this research paper we have shown that financial crisis negatively affected
following aspects of banking sector in Bosnia and Herzegovina:

Total amount of loans (of commercial banks)

Interest rates
Banking sector profitability
Increased amount of bad loans

Thereby we can say that we proved our hypothesis.

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 REFERENCES

Literature:

1. Centralna banka Bosne i Hercegovine. (2014). Godinji izvjetaji za period od 2008. do

2013. godine (2009-2014). Sarajevo: Centralna banka Bosne i Hercegovine.
2. Kozari, K. (2009). Uticaj globalne finansijske krize na Bosnu i Hercegovinu sa fokusom
na bankarski sistem.
3. Bosna i Hercegovina Ekonomski trendovi (2009) Godinji izvjetaj
4. auevi, F. (2009), Globalna recesija i njene refleksije na BiH, Forum Bosnae,
Sarajevo
5. Magazine: BosniaForum Crisis of Bosnian and Herzegovinian economy: beginning of
the end or end of the beginning
6.

Web pages:

1. www.investitor.ba
2. http://www.cbbh.ba (central bank of Bosnia and Herzegovina)
3. http://www.bhas.ba (Agency for Statistics of Bosnia and Herzegovina)

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 APPENDIX

1. Banking sector key data (in thousands of KM)

Total loans net

Number Net Average Total Total of interbank Total financial
Y Q of banks capital equity capital assets Total loans loans liabilities
19.570.00
2007 Q4 32 2.345.118 1.661.884 NA 3 11.595.307 11.563.656 17.419.843
20.812.64 14.039.86
2008 Q4 30 2.637.413 1.909.061 NA 7 4 14.025.637 18.429.457
20.608.07 13.496.64
2009 Q4 30 2.642.819 2.155.934 2.209.445 7 5 13.486.889 18.216.248
20.415.96 13.935.89
2010 Q4 29 2.730.078 2.263.392 2.402.030 4 0 13.922.822 17.811.534
20.995.10 14.637.07
2011 Q4 29 2.826.384 2.416.384 2.858.364 9 5 14.619.831 17.950.917
21.186.26 15.213.08
2012 Q4 28 2.813.528 2.565.238 3.011.296 9 8 15.201.911 18.008.102
22.023.47 15.728.02
2013 Q4 27 2.994.859 2.718.035 3.164.259 0 2 15.721.351 18.684.846

2. Total Loans of commercial banks for period 2008-2013

Date Total Loans

12/2008 14.136,1
12/2009 13.684,8
12/2010 14.145,1
12/2011 14.901,9
12/2012 15.542,5
12/2013 16.026,4

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