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Eyes on the prize

As Romania does all it can to create a smooth path towards EU membership, investors are discovering that the countries holds great promise. Matei Paun reports from Bucharest.
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Romania’s banking sector is on fire. After years in which Romanian banks acted more as investment funds, buying up the government’s local currency bonds, they now seem to have rediscovered their principal raison d’etre.

On the back of strong economic growth and lower inflation, lending has resumed to the extent that it has raised the concern of the National Bank. Deposits are growing and new banking products appearing. Capital markets are booming, mortgages are preparing to do the same and business plans for pension funds are being drawn up.

With a population of 22 million, Romania is among the largest countries in central and eastern Europe. A recent survey by German market research institute GfK concluded that as much as 62% of the population does not use banking services. It should then come as no surprise that Romania’s banking intermediation rate is only around 33%, well behind its more advanced neighbours, such as Bulgaria at 45%, Hungary at 68% and the Czech Republic’s 68%, which brings it nearly in line with EU levels.

A recent study by the Austrian National Bank points out that “If banking sector assets per inhabitant in Romania reached the same level as they presently retain in Poland, this would imply a medium-term expansion potential of close to 400%.” Clearly, this is a market one cannot afford to ignore.

Beware of clouds

A joint IMF/World Bank Financial System Stability Assessment report issued in late 2003 reveals that Romania’s banking system is in good shape overall, though careful observers will note some dark clouds do loom.

Banks appear to be well-capitalised and liquid, though this is unlikely to last, as at the same time, they are rapidly increasing their exposure to credit and market risks. The report notes a need for more confidence in banking in order to facilitate further growth.

In order to attain increased confidence, the report recommended that privatisations continue, audit and accounting practices be made more transparent and investor and creditor rights be strengthened. Also, there should be better payments discipline and judiciary system efficacy improved.

More specifically, the report suggests bank’s loan exposures be more closely monitored, particularly in the case of foreign exchange lending, which accounts for more than half of all lending. Should Romania’s currency lose its lustre, it could result in pressure on the quality of loan portfolios.

While the Romanian banking system’s capital adequacy ratio has been quite high in recent years (ranging from 18% to 29%, well above the 12% minimum required), it has been dropping rapidly as banks take advantage of lending opportunities.

While larger banks are still enjoying high liquidity, medium-sized institutions are beginning to feel the pressure of having low liquidity ratios, which, unsurprisingly, has resulted in upward pressure on deposit rates. Banks will have to monitor carefully the quality of their credits as well as their currency risk.

Consoliding & expanding

In 2001, foreign banks held a market share of 38% in the banking sector. Today, the figure is more than 50%,

having reached 44% in 2002. BRD has been privatised to Société Générale, Banca Agricola to Raiffeisen, Bancpost to EFG Eurobank, and Banca Comerciala Romana (BCR) has shed 25% of its shares to the European Bank for Reconstruction and Development (EBRD) and the International Finance Corporation (IFC). Private banks are also coming into the market. Banca Romaneasca was sold to National Bank of Greece, and the sale of Banca Comerciala ‘Ion Tiriac’ is expected to be finalised shortly.

Macroeconomic stability has brought down interest rates. Average lending interest rates peaked at 53% in 2000, but were in the mid-20s in 2003. Deposit rates dropped to 10%-11% from a recent high of 33% in 2000.

Lending has grown strongly. Exposure from loans granted grew by 72% in nominal terms between December 2002 and December 2003. In particular, real estate-related loans have jumped by around 300%, although they account for only slightly more than 5% of total credits.

Equipment purchase-related lending soared by about 50%, accounting for slightly more than 20% of the total. Working capital loans, the largest lending category at 50% of total credits, saw the least amount of growth, by around one-third. Also, as they grow, loan maturities get longer.

Total deposits in the banking system at the end of December 2003 stood at around x10bn, up by 23% in nominal terms over 2002. Household savings, accounting for only 25% of total domestic liabilities, grew by only slightly more than 11% in nominal terms.

Clearly, this points to potential future maturity mismatches if banks fail to attract long-term funding. It should not come as a surprise then that solvency ratios have declined from a recent high of 29% in late 2001 to just less than 20% in December 2003.

So far, though, banks have maintained control over the quality of their loan portfolios. Though the total past due and doubtful claims versus total assets ratio did move up somewhat in mid-2003 to around double the average for the past several years, it did finish the year with 0.23, the same as in 2002.

The EU’s role

EU accession has significant implications in the development of the Romanian banking sector. There is broad-based political support for EU accession across party lines, and much preparation is being made for 2007, Romania’s expected entry date into the EU.

Investors are now keen to repeat their successes from the first wave of accessions. Lower labour costs and new markets are attracting the foreign direct investment that has eluded Romania for the past 15 years. This process is not without its share of hiccups, but it is the principal driving force behind Romania’s recent development.

Last year’s annual EU report on Romania failed to designate the country as having a “market economy,” unlike its rival neighbour, Bulgaria. Recently, several prominent members of the European Parliament have lobbied for a more stringent approach to Romanian accession. This has caused much consternation and helped launch a concerted effort towards making up for lost time. Ministers have been reshuffled, promises made and the media courted, all in a bid to avoid a derailing of the accession process that should lead to Romania’s accession.

For this to happen Romania should finalise negotiations with the EU on a remaining eight chapters, which includes sensitive areas, such as competition, agriculture and environment. Also, the EU has demanded that Romania enter into another agreement with the IMF to ensure against “slippage.” It is hoped that this ambitious schedule will lead to the signing of an Accession Treaty in 2005, in time for official EU membership in 2007.

Undoubtedly, Romania’s banking sector has turned a corner. Yet challenges, though different from those of the past, do remain. If emerging markets were without problems, they would be emerged, not emerging. Nimble and aggressive banks with the courage to back up a vision are sure to do well here in the coming years.

In association with Banca Comerciala Romana

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