Guy Norton in Zagreb -

These are trying times for Slovenia's banks, not so long ago regarded as being amongst the best managed and most financially stable in Central and Eastern Europe. That upbeat view has changed radically as a result of the euro debt crisis, which has taken a heavy toll on the Slovenian economy and caused bad loans to rise as high as 20% of total lending at some banks.

The trials and tribulations of Slovenia's financial institutions are now increasingly regarded as stemming from the country's halfhearted move from a Yugoslav-style command economy to a Western European capitalist model.

As Dutch academic Rok Spruk from Utrecht University recently noted in a research paper for the London-based think-tank, the Centre for Research into Post-Communist Economies, entitled "After 20 years of Status Quo: The failure of gradualism in Slovenia's Post-Socialist Transition", the Slovenian banking sector remains largely a pawn of the country's domestic political players, with the government still owning roughly two-thirds of the country's banking assets. "A concerted effort to boost far-reaching privatisation and systematic restructuring has failed, mostly because of the pervasive influence of a network of former-communist politicians and businessmen. They favour direct influence in capturing the banking sector so as to establish and secure favourable lending relationships. So far, the absence of a privatisation mechanism has produced a weak and unaccountable banking sector."

Spruk adds that the only viable option to liberalise the banking sector would be through the wholesale privatisation of the state-owned banking sector to foreign institutional investors. "Yet the degree of systemic and hidden corruption in the Slovenian financial sector is so high that privatisation to domestic owners would not resolve the inefficiencies produced by 20 years of state ownership."

Arguably a direct result of Slovenia's imperfect economic metamorphosis is the fact that in 2011 the country's banking sector reported a record loss of €356m and was forced to put aside €1.1bn to cover impaired lending to cash-strapped Slovenian corporates, especially those owned by domestic tycoons who have racked up the bulk of those debts as the economy has tanked. The Slovenian economy is now firmly entrenched in the second phase of a double-dip recession, with GDP forecast to shrink by at least 0.9% this year, following a 0.2% contraction in 2011.

According to recent statements by the central bank governor, Marko Kranjec, Slovenian banks face an even tougher 2012 due to a combination of government spending cuts, growing unemployment and rising personal as well as corporate bankruptcy rates. This will all inevitably lead to lower domestic demand for banking services, while the sector's weakening ratings profile means that the supply of hitherto plentiful, cheap funding from abroad will be severely reduced.

That's also the view taken by ratings agency Moody's Investors Service, which has posted a negative outlook on the prospects for the Slovenian banking sector. "Asset quality pressure and the euro debt crisis are weighing on the sector's solvency and threaten its ability to continue to access private funding markets," says Moody's.

Off with his head

The deteriorating conditions in the Slovenian banking sector have increasingly led to a growing number of casualties among the country's leading bankers in recent months, who have been forced to resign as a result of a toxic cocktail of political and business scandals.

In December, for example, Bozo Jasovic, chief executive of Nova Ljubljanska Banka (NLB), the country's leading lender, stepped down amid the political controversy of state-owned NLB's role as the head of a shareholder consortium that was proposing to sell a majority stake in Slovenia's leading supermarket to Croatia's Agrokor, owner of rival retailer Konzum. The main challenge facing his successor, who is yet to be appointed, is where to find €400m of fresh capital by to improve NLB's core Tier 1 capital ratio to above the 9% minimum required by the European Banking Authority.

Recently installed Finance Minister Janez Sustersic has announced that the government is looking to cut its stake in NLB from 55% to 25% in the next few months precisely so that the cash-strapped Slovenian government will not have to make a major contribution to NLB's planned recapitalisation, which it is reportedly looking to delay until later in the year in order to give it a better chance of finding a buyer for its stake. NLB recorded its third consecutive loss last year, ending up €239m in the red after putting aside €480m to cover bad loans.

Meanwhile, the country's second biggest lender, Nova Kreditna Banka Maribor (NKBM), has had no less than three chief executives in almost as many months. In December, Matjaz Kovacic, who had run the bank since 2005, stepped down amid suspicions over his dealings with construction company Konstruktor, one of NKBM's major clients. At the heart of the alleged scandal surrounding Kovacic is the 2009 sale of his apartment to Prava Pot, a company that took out a loan from Konstruktor to buy the property for €300,000. The money was never repaid to Konstruktor, which is now in receivership. NKBM board member Andrej Plos was then named as Kovacic's successor effective from January 1, 2012, but lasted little more than six weeks in the job before tendering his notice.

As of mid-March, the bank, which is 51% state owned, has been being led by Ales Hauc, the former boss of postal operator Posta Slovenije, who is in no doubt that things will have change at the bank. "Non-performing activities will be eliminated," he announced on taking the helm at NKBM, adding that in future the bank will have to work harder to win both new business and investor confidence. "The times when companies came to the bank are over, now the bank needs to actively market its services."

He added that NKBM would also be more engaged with potential investors and existing shareholders to ensure the bank's future attractiveness for investment following a €104m secondary public offering on the Warsaw Stock Exchange last year.

The raft of poor financial results and resultant rating downgrades in the sector has inevitably taken its toll on the investment attractiveness of the banking sector, as evidenced by the failed sale of a majority stake in the country's third largest lender, Abanka Vipa, earlier this year. A consortium of shareholders with a combined stake of 75.7% had been looking to exit the bank since November 2010, but with conditions in the sector deteriorating and potential buyers increasingly thin on the ground, in January the group accepted the findings of investment bank ING which had been advising it on the sales process that no binding bids for the stake would likely be forthcoming in the foreseeable future. Abanka Vipa reported a loss of €119m last year, giving wannabe investors little incentive to buy into an already financially embattled institution.