Financial Stability Report No1 20 December 2010 - Banka Qendrore ...

Financial Stability ReportNumber 1Operational costs as the most important component of the intermediation cost have showna declining tendency since 2005. In 2009, operational costs explained 4.48pp of total ex postcosts, compared to 6.13pp in 2005. The higher level of operational costs in the first years ofthe operation of Kosovo’s banking sector might be attributed to the need for expandingbanking sector network. This expansion led to a higher level of expenditure that wasneeded to open and functionalize branches and other infrastructure. In 2009, it may beconsidered that the banking sector has vastly completed the expansion of its network andthe banking services are available around the country. In addition, in the first years ofoperation, banks incurred additional costs on staff training and other expenses, taking intoconsideration that at that time the market could not provide experienced staff for thisindustry. According to a study conducted by the World Bank (2010), wages for the financialsector in Kosovo are highest compared to other sector of economy. This is measured throughthe wage difference between the financial sector and low-skill sectors (construction,catering and retail trade). The wage differential between financial sector and other sectorsin Kosovo is the also highest compared to countries in the region. For example, compared toMacedonia, the wage differential is for 50 percent higher, whereas compared to Croatia it isfor 100 percent higher. This sheds some light on cost inefficiencies in Kosovo’s bankingsector. 15Unlike previous years, when operational costs represented the largest component ofbanking sector ex post costs, in 2009, risk costs were the largest component accounting for5.08pp of total costs. Risk costs have shown an increasing trend in the last five years,mostly due to credit growth and higher risk-taking that took place during this period. Thelarger contribution of risk costs to the total costs in year 2009 presumably reflects thedeterioration of real sector conditions during this period as a consequence of global crisis.This resulted in the increase of non-performing loans from 3.3 percent in 2008 to 4.3percent in 2009. Funding costs represent another category that has continuously increasedits contribution to the overall ex post costs. The increase of funding costs primarily reflectsthe increase of deposit interest rates especially during 2008 and 2009. This period has beencharacterized with new entries in the Kosovo’s banking sector, which intensified thecompetition among banks in attracting deposits. In addition, high rates of credit growthduring this period necessitated the attraction of larger amounts of deposits in order tofinance the credit growth. These developments had a positive impact on deposit interestrates, increasing the cost of finance for the banking sector.9.4 ConclusionsThe interest rate spread in the banking sector of Kosovo is considered to be high comparedto the countries in the region. High interest rate spread in Kosovo primarily reflects highlending rates. On the other hand, deposit rates show an increasing trend, thus modestlynarrowing the interest rate spread. This study found that lending rates in Kosovo aremainly explained by operational and risk costs. In the cost structure of banks in Kosovo,operating costs are predominantly the most important category. Costs in the adoption oftechnological advances for upgrading banking products and services, a shift towards thesegments of small business sector which are more costly led to higher operational costs.Also start-up costs or cost of acquiring domestic banks, and costs in further building human15 See also Toçi (2009) for relative inefficiencies in intermediation in the Kosovo banking sector.| 81