UPDATE 1-Czech financial sector stable and financially strong -c.bank
* Czech banking sector remains resilient
* In adverse scenario, CZK 18 bln cash injections seen
* Low provisions for non-performing loans a possible risk (Adds governor comments, non-performing loans, stress test scenarios)
PRAGUE, June 17 (Reuters) - The Czech financial sector is stable and could withstand a strong recession accompanied by deflation thanks to capital buffers, the central bank said on Tuesday.
The main risks to the sector were a possible return to recession because of developments in trading partners as well as a deterioration in domestic demand, the central bank said in its regular financial stability report.
"(Global) central banks and supervisory authorities are facing the task of avoiding a renewed decline in demand and a fall of economies into the deflation trap, and at the same time preventing excessive risk-taking on financial markets," the central bank (CNB) said.
"The CNB is actively preventing the risk of a drop in demand and deflation by using the exchange rate as a monetary policy instrument, which is contributing to the stability of the financial system."
The central bank launched interventions in November to weaken the crown currency and fight deflation risks as the economy recovers from a record-long recession that ended in 2013.
The bank said another possible risk for the banking system stemmed from non-performing loans where the provisions set aside by the banks "might not be sufficient" due to the worsening profile of those loans.
Non-performing loans made up 6.5 percent of all loans at the end of the first quarter compared to 6 percent at the end of the same period last year, Czech Banking Association said in May.
"It is a universal state of the sector, on the other hand the sector is quite highly capitalized, so the buffer is there somewhere else than in the provisions," Governor Miroslav Singer said at a press conference.
The bank's semi-annual banking sector stress tests showed Czech banks would go through a series of adverse scenarios without significant trouble.
In the scenario called "Euro zone in deflation" adjusted for writedowns of bonds issued by the most indebted member states, total cash injections would reach 18 billion Czech crowns ($888.58 million), or 0.5 percent of the gross domestic product.
In the baseline scenario, seen by the bank as the most probable, only two banks - representing less than 1 percent of the sector's overall assets - would fall below the capital adequacy requirement (CAR) of 8 percent, the bank said.
Czech banks have been relatively unscathed in the half-decade since the global financial crisis.
The largest Czech banks are units of Austria's Erste Group , Belgium's KBC, France's Societe Generale and Italy's UniCredit. ($1 = 20.2570 Czech Korunas) (Reporting by Robert Muller and Jason Hovet; Editing by Andrew Heavens)