There are two major sources of concern about Slovenia's financial situation. The first is the health of its banking sector and its increasing need for recapitalization. The second is the possibility that the state may be forced to provide the banks with several bailouts, which would in turn undermine public finances.

Problems in the Banking Sector

Slovenian banks are dealing with a high rate of unpaid loans (the ratio of nonperforming loans accounts for 15 percent of gross customer loans) and are experiencing increasing difficulties in their efforts to recapitalize. With banking assets close to 150 percent of Slovenia's gross domestic product and a loan-to-deposit ratio near 180 percent (the European average is around 110 percent), Slovenian banks are among the most leveraged in the region.

Slovenia's banking sector is highly concentrated, with only three banks accounting for half of the sector. Moreover, Slovenia's first- and third-largest banks (Nova Ljubljanska Banka and Abanka Vipa, respectively) are controlled by the state. This means that the burden of recapitalization falls mainly on the public sector. The Slovenian state has been helping banks in distress since the beginning of the crisis, and more capital injections will be needed in the future. This in part explains the rapid growth of Slovenia's sovereign debt in just four years (from 23 percent of GDP in 2007 to 45 percent in 2011).

Slovenia has struggled recently to find private-sector funding. Belgium's KBC bank on July 3 withdrew a proposal to participate in the recapitalization of Nova Ljubljanska Banka. This forced the government to announce that it would provide the necessary funds for the recapitalization, estimated at 381 billion euros. In March, a lack of private interest pushed the state to buy a 250 million euro share issue by Nova Ljubljanska Banka. Slovenian Finance Minister Janez Sustersic then admitted June 19 that the bank may need an additional 500 million euros in the near future.

The June 28-29 EU summit brought some relief to Slovenia. After an agreement reached during the summit, the European Stability Mechanism could directly support eurozone banks. This would allow Slovenia to ask for a bailout for its banks without increasing its sovereign debt. However, this system has yet to be implemented, and there is still uncertainty about the extent of the Slovenian state's liability in any banking sector bailout.

Furthermore, even if the aid were channeled directly to the banks, the European Union would require Slovenia to reduce spending and implement reforms. 

Struggle to Implement Reforms

Slovenia is still trying to recover from the impact that the European crisis had on its finances. In 2011, Slovenia's budget deficit reached 6.4 percent of GDP. The country plans to cut the deficit to 3.5 percent of GDP this year and to 3 percent in 2013, but that will not be an easy task. With the European crisis dampening demand for its exported goods, Slovenia fell into its second recession in three years in the last quarter of 2011. Though the Slovenian economy grew 0.2 percent in the first quarter of 2012, the Organization for Economic Co-operation and Development expects Slovenia's GDP to shrink by 2 percent for the year.

Ljubljana this year adopted measures to reduce spending by about 800 million euros. The reductions included cuts to public-sector wages and social benefits. The government has also announced plans to sell all or part of state-owned entities, including Nova Ljubljanska Banka, where the government hopes to reduce its 55 percent stake to 25 percent.

But structural reforms in Slovenia often meet strong social resistance. In a June 2011 referendum, Slovenian voters rejected a pension system reform that would have extended the retirement age to 65. (The current retirement age is 57 for women and 58 for men.) The government has stated its intent to bring the reform back up for discussion in 2013. This will likely generate new clashes with unions.

Attempts at labor reform also face solid opposition. About 15,000 people (in a nation of 2 million) took to the streets in Ljubljana in May 2010 to protest legislation that would limit some citizens — mostly students — to working only low-wage, part-time jobs. In January 2011, the Association of Free Trade Unions, Slovenia's largest national trade union confederation, staged demonstrations throughout the country to protest spending cuts. Earlier this year, pressure from trade unions led the government to abandon plans to reform the income tax system.

Furthermore, the Slovenian government has little political room to maneuver. Jansa's Slovenian Democratic Party leads a fragile coalition of five parties. The coalition was the result of a last-minute agreement after Zoran Jankovic, whose Positive Slovenia party won elections in December, failed to form a government. As a result, Jansa's government lacks cohesion and could fragment in the face of sustained opposition to its policies.

Given the severity of Slovenia's financial need and the relatively small size of its banking sector, securing an EU bailout would be the relatively easy part. Coping with public displeasure with the accompanying austerity measures would be much more difficult.