At first glance, the headlines trumpeting emergency support for banks in Central and Eastern Europe evoke the spectre of the turmoil of the eighties and early nineties. “Eastern Europe’s banks to get billions”, bannered one international news organisation about late February’s $25.4bn tripartite, liquidity package put together by the European Bank for Reconstruction and Development, European Investment Bank and the World Bank.
Individual countries have also sought and got help. Hungary gratefully booked its own $25bn package, this time from the IMF. Several Russian banks have successfully appealed for equity and debt finance from the EBRD and other international institutions, as have Romania, Ukraine, Russia and Georgia, Belarus and Serbia. Meantime, Latvia, another client of the IMF, went back to its benefactor in March to seek another round of funding, but on softer terms.
The casual observer could be forgiven for thinking that the banks of the region are in serious trouble as a result of the same loose lending practices, reckless leverage and short-term funding that triggered the financial meltdown in the west. In short, delinquent institutions. As it happens, the institutions that have galloped to their help do not entirely absolve the CEE’s banking sector from blame. Europe’s central bankers say certain institutions expanded their balance sheets too quickly with assets of dubious merit.
However, while that’s true of certain elements of the sector, it’s not true of the whole. Most CEE bankers as well as their respective central banks could give lessons in prudential banking to their western counterparts. According to experts on the region, the CEE sector is the largely innocent victim of the economic slump in the west that has hit their domestic economies hard. They also point out that several CEE nations have only recently become dependent on the west, in particular new members of the EU, and have been contaminated by the meltdown instead of enjoying the rising prosperity they expected.
A more thorough analysis of the sector tells the bigger story. Take just the size of the rescue packages. The injections of liquidity pumped into CEE banks are a drop in the ocean compared with the massive sums deployed to bail out western banks, in particular US and UK institutions. This is because the CEE industry didn’t touch investments in structured credit and other assets that subsequently turned toxic. For instance, the so-called structured investment vehicles (SIVs) where much of this high-risk paper was parked were an unknown species in Eastern Europe.
As for leverage, once again the sector as a whole resisted the temptation to break with traditionally safe practices in debt: equity ratios. No banks hiked ratios up to the stratospheric 40-60:1 levels prevailing on Wall Street. And what sound levels of leverage they practised were for the benefit of the real economy rather than for debt-fuelled, asset-backed paper. “On the whole, corporate development in eastern Europe has involved privatisations in which leverage is a lot lower [than in the west],” notes IMF research.
Still, the sector has fallen victim to the general dearth of liquidity in the west, its main funding pipeline. As an analyst at the EBRD points out, “their financing came from external sources, and so they have a refinancing risk”.
So while CEE banks were mainly sound institutions dispensing stable sources of finance in their regions, the upshot is that many of the systemically important institutions need urgent liquidity to contain the crisis and to continue to feed the real economy with credit. Meantime, their central banks are hurriedly studying western methods of strengthening protection for depositors among other, more respectable, western techniques. In short, the sector is in the middle of a rapid learning curve.
Manfred Schepers, the EBRD’s vice-president for finance and a veteran of UBS, is in the middle of helping ease the sector’s difficulties, and points out that the most vulnerable banks are those with heavy exposures to the dollar and those that borrowed on international capital markets. As Schepers summarised in a speech in Vienna: “Today, central and eastern Europe is bearing the full brunt of the global financial and economic crisis.”
Clearly, financial integration with the west created new kinds of problems for several CEE nations as well as benefits. Many are members of the EU, several have joined the eurozone and most are members of the WTO with extensive trade relationships in Europe and Asia.
The situation of the Bank of Georgia, the leading bank in the Caucasus region, illustrates the point. The nation has made a successful transition into the global economy over the last few years, and its banks generally received top marks from the IMF and other organisations for raising their game. As Jyrki I. Koskelo, Vice President of the IFC, a member of the World Bank group, explains: “Over the past several years, Georgia’s banking sector has made remarkable progress in deepening financial intermediation and facilitating economic growth”.
However, Georgia has been hit by the meltdown, and there’s a general shortage of funding, both from local and international sources, for banks and companies. Thus, the EBRD and IFC have channeled a $200m package to the Bank of Georgia. Each has put in $100m, made up of subordinated and subordinated convertible loans of up to $50m, to support the bank’s capital base. And they have topped that with a senior loan of $50m to provide longer-term liquidity. The subordinated loans buttress the bank’s capital integrity, while the senior loan provides a pipeline of credit for the small and medium enterprises that have been the foundation of the nation’s rising prosperity.
As Varel Freeman, EBRD first Vice President, points out, the Bank of Georgia would not have qualified for the package if it were not robust. “The EBRD is ready to support structurally sound clients to overcome the current crisis,” she adds. “This is the key for the preservation of a sound banking system and the return to sustainable growth in the future.” The bank also qualifies because it’s systemically important with a market share of 34 percent of total assets, 33 percent of total loans and 30 percent of total deposits.
The EBRD is constantly studying other targets for its liquidity-boosting packages. This year, it says, EBRD-led financing could top $20bn as it steps into the breach. A conservatively run institution that was criticised until recently for its high levels of liquidity (and is now praised for it), the EBRD’s overall strategy is not to save banks ‘too big to fail’, as in the United States and Britain, but to deliver sufficient loans and equity to financial institutions so they can continue to finance the real economy. Top of the agenda, according to Schepers, is trade finance because it is the fuel that binds the region together.
A new, $75m subordinated, ten-year loan to Ukraine’s Raiffeisen Bank Aval, a subsidiary of Raiffeisen International AG, further underlines the EBRD’s strategy. Amid the virtual closure of international money markets, it’s a long-term facility that boosts the capitalisation of the bank, and allows it to continue lending through nearly 1,200 outlets to no less than 196,000 SMEs and 9,000 corporates, which adds up to a fair-sized chunk of Georgia’s business community.
Until this crisis, the general story of CEE banking was overwhelmingly positive. Over the last 10-15 years, the sector managed to fuel rapid industrialisation and growth without putting itself at risk. Since the 1990s, domestic credit as a share of GDP has climbed steeply. An immediate result was robust economic growth, higher incomes and, as an IMF study reports, ‘financial integration with more developed countries’.
During that period, foreign banks swooped on the sector, particularly Nordic institutions, and bought up many of the largest and most profitable networks. In general, the research concludes, the benefits were positive. Credit from bigger and better-capitalised parent banks based in larger economies helped feed industrial growth. Deeper-pocketed, foreign parentage also reduced the cost of borrowing by introducing more competition, ushered in improved IT systems and other efficiencies that worked to the benefit of the CEE sector.
The mounting influence of foreign banks rapidly changed the landscape across the CEE. In the Czech Republic, for example, the market share of foreign-owned banks shot up from 77 percent to over 93 percent in just four years between 2001 and 2005, according to the most recent figures from the European Construction Bank. In Slovakia, foreign market share increased by over 14 percent – from 85 percent to 99.5 percent – in six years, in Latvia by 13 percent, in Lithuania by around nine percent, and in Slovenia by over seven percent. It’s no accident that economic growth was rapid in those countries.
Interestingly, the growth in penetration of foreign banks is lowest in nations that are hurting most from the downturn. For instance, in Hungary, it’s around 59 percent, roughly the same as it was in 2000.
But what’s going to happen now in CEE banking? There are fears that some of the western parents may turn off the tap, in particular those accepting state-funded packages on the specific condition that they be held domestically rather than extended to their CEE subsidiaries. Indeed, in late March, Robert Zoellick, President of the World Bank, warned about the danger of liquidity being sucked out of the CEE sector as a whole. And within the CEE, bankers complain at having to ‘sit on their hands’ and wait for parent banks to bail them out.
Others see the crisis as an opportunity for the sector to become more independent. Radovan Jelasic, governor of the National Bank of Serbia, believes it is essential that CEE banks learn to stand more on their own feet in terms of funding and rely less on international pipelines.
“Most countries in the CEE greatly underestimate the problems they will face in 2009 and 2010 as their economic models – built on foreign direct investments, foreign borrowing and, for the regional members of the European Union, additional funds from Brussels – need a complete overhaul,” he argued in a recent article. He appeals for ‘a long overdue adjustment’ in the form of fiscal and structural reforms including pensions, healthcare and education.
Certainly, the meltdown has served to dispel the illusions of many CEE bankers about the financial integrity of the western sector, and is likely to jolt them into adopting systems of governance and management that would make their own institutions less vulnerable. However, nobody is predicting a U-turn in economic integration. As economists overwhelmingly point out, that would be as disastrous for the west as for the CEE.