Development banks stay in fashion in eastern Europe

In its May 2011 update, the European Bank for Reconstruction and Development (EBRD) forecast economic growth in 2011 and 2012 for all 29 countries in its area of operation. It is an impressive recovery for some of the emerging markets that were worst hit by the global financial crisis, with countries such as Estonia and Ukraine seeing double-digit declines in gross domestic product (GDP) during 2009.

As economic prospects dimmed and private fund flows to the region dried up in 2009, multilateral development banks dedicated to central and eastern Europe (CEE) and central Asia stepped in. They provided capital, financing and loan guarantees to avoid an even more severe slump in output. New programmes were crafted specifically to tackle the crisis.

Tackling the crisis

One of those was the Eurasian Economic Community Anti-Crisis Fund (ACF), which was created under the management of the Eurasian Development Bank (EDB), but run on a separate balance sheet. The EDB itself is a young institution, founded by the governments of Russia and Kazakhstan in 2006, with Armenia, Belarus and Tajikistan joining subsequently.

The $8.513bn ACF was created in 2009 and has the same membership as the EDB, plus Kyrgyzstan. Russia paid in $7.5bn, Kazakhstan $1bn and the other four members $13m between them. Sergey Shatalov, who spent almost two decades at the World Bank, was appointed managing director of the ACF and a deputy chairman of the EDB’s executive board in 2010, with an additional responsibility to deepen the EDB’s co-operation with other multilaterals.

Mr Shatalov says the aim of ACF is to provide financial support in a fiscally responsible form, drawing on expert staff and general programme models from other multilaterals. One of the ACF’s tools is a budget and balance of payments stabilisation package similar to International Monetary Fund (IMF) programmes.

“We would not put money into a distorted economic system unless the government is strongly and firmly committed to reforms that bring the system to sustainability in the medium-term. That is very similar to the World Bank or the IMF,” says Mr Shatalov.

Plugging the budget shortfall

The ACF made its first stabilisation disbursement of $70m to Tajikistan in August 2010, helping alongside the EBRD and World Bank to plug a severe budget shortfall for the year. The country had suffered catastrophic mudslides that cost about 5% to 10% of national output and also faced adverse markets for its major commodity exports, especially cotton. In June 2011, a far more substantial programme of $3bn was approved for Belarus, which was in the grip of a balance of payments crisis and had devalued its currency by 56%.

“We now have a strong commitment from the Belarus government to achieve a medium-term stabilisation of the current account,” says Mr Shatalov.

The ACF’s other tool is to make specific project-based loans (with a grant element for the poorest members) for sectors that can achieve significant economic stimulus, including energy, export processing (especially in agriculture) and transport. Mr Shatalov says there is a pipeline of about $2bn of such projects, and the loans can even be made to companies rather than governments, as long as suitable collateral is provided.

These project loans cross into the core territory of the EDB itself and Mr Shatalov says there is provision for joint lending for suitable high-impact investments. However, the ACF is mainly intended to focus on situations where the private sector or EDB would not be able to fund on terms or with maturities that would be viable for the project.

Delicate balance

For such an anti-crisis initiative, there is always a potential tension between providing assistance and maintaining a well-managed loan portfolio. The Belarus programme was subject to several weeks of debate before approval and a recent Fitch Ratings report on the EDB closely examined the effects of the ACF (which lends with much lower rates than the EDB) on overall portfolio quality.

“There is always heated discussion on how to balance stimulus and loan quality. Representatives from the two countries in the ACF with the lowest GDP per capita, Tajikistan and Kyrgyzstan, which are more likely to be recipients, still ask just as many questions about the quality of each project as the major financing countries [Russia and Kazakhstan],” says Mr Shatalov.

Beyond Vienna

The crisis in Belarus is a stark reminder that many of the CEE countries are still at an early stage of transition, with markets and financial systems that are vulnerable to dislocation. One of the most prominent programmes at the peak of the crisis was the Vienna Initiative, a deal struck in the Austrian capital city in early 2009 in which multilateral institutions agreed to backstop financing in the CEE region.

In return, western European banks promised to keep their CEE subsidiaries well funded to avoid a sudden stop in lending activity in countries where as much as 90% of the banking sector was foreign-owned. In badly hit economies, such as Ukraine or the Baltic states, that meant parents recapitalising some of the foreign-owned banks that were hit with heavy losses in 2009.

The EBRD was a prime mover in the Vienna Initiative and it substantially increased its portfolio allocation to the CEE financial sector. Nick Tesseyman, managing director of financial institutions at the EBRD, says that aside from three deep restructurings – BTA Bank in Kazakhstan, Parex in Latvia and Kreditprombank in Ukraine – and a number of state-led rescues among Russian banks, the region's banks fared remarkably well during the crisis. The EBRD’s equity, subordinated debt and loan operations to CEE financial institutions made at the time of the crisis have performed strongly.

The work continues

Mr Tesseyman says the risk of mass withdrawal by Western banks in the CEE region has gone and some are once again highlighting growth opportunities. But the EBRD is still working on cleaning up some of the consequences of the crisis and making the region more resilient in the future. The next steps in the Vienna Initiative include understanding the implications of the Basel III regulations for CEE banks, and tackling residual non-performing loans (NPLs). In many cases, CEE banks are already highly capitalised, but NPLs are persistent in countries such as Kazakhstan, which suffered heavy declines in real-estate markets.

To build sustainability in the future, the EBRD is seeking to foster a structural shift in CEE bank balance sheets away from foreign parent funding toward more use of local capital markets. But Mr Tesseyman acknowledges it is a long-term mission that has been set back somewhat by events in Hungary and Poland, which have renationalised (in the case of Hungary) or cut state contributions to the private second-pillar pension system.

“Looking at the need for long-term local investors and capital in those markets, it cannot be positive that some of these reforms are being rolled back. The EBRD as a project-based investor supports private pension and insurance providers in those countries when we can, but this sector has been much slower to develop than banking. We want to keep people focused on the need for stronger local markets, to avoid foreign banks slipping back to pre-crisis practices of lending in Swiss francs or Japanese yen for competitive reasons,” he says.

New challenges

For one multilateral in the region, the financial crisis is far from over. The Black Sea Trade and Development Bank (BSTDB) includes among its shareholders the Greek government, whose credit ratings are now well below investment grade as expectations rise of a sovereign debt restructuring.

However, credit ratings on BSTDB were actually raised in 2010 and are now higher than any of its 11 shareholders, which are all governments of countries in the wider Black Sea region. The bank’s president, Andrey Kondakov, says credit analysts have concluded that the bank’s asset quality and liquidity management are more important than the creditworthiness of one shareholder. The bank has just one NPL in a portfolio of 106 investments and that problem predates the financial crisis.

“There have been no new NPLs as a result of the crisis, and although we have had to restructure some loans, especially in Ukraine, these were project loans rather than funding programmes to banks and they are all still performing,” says Mr Kondakov.

Indeed, he says that the loss of cheaper private funding that used to be associated with EU membership for member countries Greece, Romania and Bulgaria has meant more demand for funds from the BSTDB. To devise country programmes for each member under the bank’s new three-year strategy, Mr Kondakov, who became president in 2010, has pioneered a more intensive process of country visits by BSTDB management and staff.

“Senior management had always visited each member state as we have no local offices. What is new is that we are now accompanied by our bankers and strategists on each visit,” he says.

The bank is targeting 70% portfolio growth across the life of its 2011 to 2014 strategy, including more co-financing of municipal infrastructure, and raising equity participation, which is currently 3% of the portfolio. Mr Kondakov believes it can also meet its target of ensuring that 20% of the total portfolio is based in the smaller shareholders – Albania, Moldova and the three Caucasian states of Georgia, Armenia and Azerbaijan.