Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
Central & eastern EuropeSeptember 2 2003

Bank rescues under scrutiny

Share the article
twitter-iconcopy-link-iconprint-icon
share-icon

Huge bail-outs of state banks before their privatisation are coming back to haunt the Czech Republic in the form of EU pre-accession scrutiny. Robert Anderson reports from Prague.

As though paying Kc500bn ($18bn) to rescue the country’s insolvent banking sector was not bad enough, the Czech government now faces the threat of a European Commission (EC) investigation into whether this state aid was justified.

If the Czech government cannot justify the bail-outs to the commission’s satisfaction, Brussels could demand that part of the aid be returned after the country joins the EU next May. This would put the government on a collision course with the foreign banks that now control the former state-owned lenders.

“If the EU doesn’t approve the aid then banks will go to the government and say you didn’t live up to the terms of the privatisation agreements and you have to adjust the purchase price,” says one financial sector executive.

Bail-outs spark dispute

The dispute centres on the huge bail-outs given out at the end of the 1990s to Ceska Sporitelna, the main retail bank, Komercni Banka, the main corporate lender, and Investicni a Postovni Banka (IPB), which was taken over by Ceskoslovenska Obchodni Banka (CSOB) after a liquidity crisis in 2000.

Under the centre-right governments that held power until 1997, the banks were kept in state hands and encouraged to lend to entrepreneurs and the companies they bought from the state. As Vaclav Klaus, the former premier, has admitted, privatisation was postponed because it would turn off the tap of credit on which companies relied.

The consequence was poor credit decisions – because of inexperience, political interference and plain fraud – leading to the creation of a huge volume of loans that will never be repaid. When the economy entered recession in 1997, the three big banks in reality became insolvent because their clients could not repay their loans, even if they had any intention of repaying them in the first place.

Under the first Social Democrat government of 1998-2002, the big banks were extensively cleaned up so that potential buyers would look at them.

Komercni benefited from a Kc9.5bn equity injection and the government bought Kc83.1bn of problem loans and guaranteed to cover potential losses of Kc20bn on part of the remaining portfolio.

Ceska Sporitelna received a Kc7.6bn capital injection and Kc43.7bn of loans were carved out, plus another Kc14.5bn worth were handed back after privatisation.

At IPB, CSOB has returned Kc105bn of assets so far and a further Kc43bn of offshore assets should be transferred shortly. This will mean that just over half IPB’s assets will end up back in state hands. Because of the poor quality of these assets, the government estimates that its loss on reselling IPB’s portfolio will reach around Kc100bn.

The government estimates that the total cost of the bail-outs since the fall of Communism in 1989 is about Kc500bn, making it the most costly rescue programme in central Europe.

The bail-outs were essential to the privatisation of the banking sector, though. CSOB, the only relatively trouble-free bank, was sold to KBC of Belgium in 1999, but the sale of Ceska Sporitelna to Erste of Austria in 2000 and Komercni Banka to Société Générale of France in 2001 relied on the clean-up of their portfolios and further guarantees.

Investigation under way

This process is now being investigated by the Czech competition office on behalf of the EC to check if it violated the state aid provisions of the country’s Europe Agreement with the EU. The issue was left unresolved during the Czech Republic’s negotiations with the EU, which led to a formal invitation to join last December. The Europe Agreement dictates that provision of state aid is only permissible if accompanied by a restructuring plan and counter-measures to alleviate any distortion of competition.

If the competition office finds that the state aid cannot be justified, or if the EC is unconvinced by the competition office’s investigation, Brussels could insist on the return of the aid once the Czech Republic enters the EU next May. If the commission is satisfied with the government’s case, the issue of the rescue of the banks cannot be re-opened once the country joins the EU.

CSOB, Komercni and Ceska Sporitelna are putting together information for the competition office. “Everyone’s approaching this very seriously,” says one financial sector executive. “There would be claims if Brussels demanded the return of the aid. Everyone is aware of this and wants to avoid it.”

Government defence

The government will shortly advertise for an investment bank to prepare its defence. It has said that this defence should be ready by the end of the year and that the whole process will be concluded in about six months.

The government is downplaying the importance of the probe, emphasising that state aid in various sectors in several countries is being investigated before EU accession. Slovakia, for example, is going through a similar process to examine the carve out of Sk105bn ($2.82bn) of problem assets from three of the country’s top banks.

“We are not afraid,” says a ministry of finance spokesman. “We can’t see any problems in this process. All the candidate countries are going through the same standard procedure.”

A question of scale

However, the Czech banking bail-out was on a different scale from those of its neighbours, raising suspicions that it was carried out merely to boost the value of the state banks before their privatisation.

“If you look at the accession countries, there is no area where there has been state aid of such a magnitude,” says Dan Jackson, managing director of investment banking at Nomura International, part of Nomura Securities of Japan.

Nomura, which held a 46% stake in IPB before its collapse, has launched a $1bn international arbitration claim against the Czech government under the Czech-Dutch bilateral investment protection treaty. It accuses the state of barring IPB from receiving state aid while giving help to its competitors. This directly led to the bank’s collapse, Nomura claims, after which the state was forced to give massive support to CSOB, IPB’s new owner.

The government has launched a counter-claim against Nomura for Kc263bn, accusing it of reneging on pledges to strengthen IPB and carrying out questionable transactions that damaged it.

Favouritism denied

Both in the IPB case and that of the other two big state-owned banks, the government insists aid was not given to favour one bank over another or to give Czech banks a competitive advantage in the wider European market. It argues that state aid was essential to save the banks and prevent a systemic banking crisis.

The new owners of the state banks agree. “If the state aid to the Czech banking sector had not been provided, the whole economy would have been seriously impacted,” says Milan Tomanek, spokesman for CSOB.

There are precedents in which the EU has accepted such arguments, notably the Crédit Lyonnais case in France.

“In the past, the EC has cleared banking cases within the EU of a much higher magnitude than what we are talking about here,” says Mr Tomanek. “On top of that, the state help in the Czech banking sector was provided in the framework of a transition economy and a systemic crisis in the banking sector, and not in a fully developed market economy.”

The problem for the Czech government is that the formal defences for providing state aid were not fulfilled: no restructuring plan was ever agreed with the banks, nor were counter-measures implemented to alleviate competitive distortions. Crédit Lyonnais, by contrast, was forced to sell its foreign branch network. Therefore, unless the Czech rescue programme is cleared for political reasons, there is a risk that it will be found to be against the state-aid rules and some repayment or counter-measures will have to be imposed.

Was this article helpful?

Thank you for your feedback!

Read more about:  Central & Eastern Europe