The space for Croatia's banks to finance the state has narrowed, while legal and fiscal risks make it impossible for interest rates to fall and thus boost a fragile economic recovery, the head of the national banking association told Reuters on Friday.

Croatia, which may face new polls after inconclusive elections last month, runs budget deficits of around 5 percent of gross domestic product, and its public debt is nearing 90 percent of GDP. Local banks' exposure to the state is already close to 25 percent of overall loans.

"Each bank runs its own crediting policy and the banks will make sure that further financing of the state remains possible, but there is no much space for the exposure level to rise," Zdenko Adrovic, whose association includes the local units of UniCredit, Intesa Sanpaolo, Erste and Raiffeisenbank, told Reuters in an interview.

"The public debt must be tamed," Reuters cited Adrovic as saying.

Croatia, the newest European Union member, is under pressure from Brussels to reduce the budget gap to below 3 percent of GDP by 2017, but so far has made little progress towards that goal.

The country is set to grow around 1 percent this year, after six consecutive recession years that wiped out almost 13 percent of the overall output.

Reuters aslo notes that Croatia aims to issue some 19 billion kuna ($2.7 billion) worth of bonds next year, half on the local market.

Despite woes felt by local businesses seeking more favourable loans, Adrovic told Reuters cheaper financing was not realistic at the moment.

Some banks have taken legal action over an enforced conversion of their Swiss franc loans into euros, resulting in a total loss for the sector which the central bank has assessed at some 8 billion kuna.

Adrovic, however, said that due to strong capital levels, with a capital adequacy ratio which the central bank put at slightly below 20 percent on average, the banking system was able to withstand the losses. "The banks have enough capital and will remain stable despite losses," he told Reuters.

The average return on capital in the banking sector in the last two years amounted to 1.8 percent, while this year it is expected to be around minus 10.0 percent. By comparison, the country's 10-year bond yields around 4.2 percent.

"We hope that the environment will improve in the coming years, so that the return on capital surpasses yields on state bonds," Adrovic said.


(EUR 1 = HRK 7.63)

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