The effects of eurozone deleveraging on central and eastern Europe should not be exaggerated, but certain countries look particularly exposed, especially in the Balkans. And the principles of European integration are under pressure.

When the financial crisis struck in 2008, markets feared that the unprecedented capital inflows to central and eastern Europe (CEE) during the boom years might sharply reverse, causing a sudden stop in the region’s economies. National central banks and regulators, multilateral organisations such as the European Bank for Reconstruction and Development (EBRD) and cross-border banking groups active in the region came together in Vienna in January 2009 to coordinate a response that helped avoid a worst-case scenario.

As the eurozone crisis intensified during 2011, those fears began to re-awaken. This time, market turmoil is combining with regulatory pressure to drive cross-border banking groups to deleverage.

“If parent banks with very significant exposures to CEE cut those suddenly because of market concerns and balance sheet enhancing measures, it could lead to a systemic crisis in the region. That is not our central scenario, but we felt, together with the International Monetary Fund and the European Commission, that the risks of uncoordinated responses were a reason to call for a Vienna Initiative 2.0,” says Piroska Nagy, policy advisor at the EBRD.

And so national policymakers and multilaterals returned to Vienna for discussions in January 2012, with a plan to bring in the private sector over the coming weeks. Ms Nagy says all parties around the table recognised the need for coordination. That may go some way towards reassuring executives at banks such as Austria’s Raiffeisen Bank International (RBI), which operates across 16 CEE markets.

“Multinationally operating banks cannot be confronted with different measures from different local regulators. What we want is that the regulators align themselves, so that we can get on with our business – nothing more, nothing less,” says RBI chief executive Herbert Stepic.

Greek banks’ market shares, 2010

Greek and Hungarian risks

While the work is underway for Vienna 2.0, there are reasons to think that the challenge may be more profound this time. The funding and capital threats to parent banks are becoming severe, especially for the Greek-owned players. The European Banking Authority (EBA) capital exercise in December 2011 estimated the capital needs of Greek banks at €30bn.

Until a credible plan to restructure Greece’s sovereign debt is in place, these banks are shut out of wholesale funding markets. And the Greek finance minister disclosed in January 2012 that the banking system had lost about 30% of its deposits over the previous two years.

Other banks are not immune, especially in Italy, where a nail-biting rights issue by UniCredit – present in 14 CEE countries – caused a 40% plunge in the share price at one stage in January 2012. Erik Berglof, the EBRD’s chief economist, says the consequences for CEE are already becoming apparent, although weak credit demand is obscuring the effects somewhat.

“There is very strong evidence of a credit contraction that is more than we would expect from the slowdown in growth. Normally, you would expect the two to move fairly simultaneously, but now the credit squeeze predates the slowdown,” he says.

Marcus Svedberg, chief economist at Sweden’s East Capital, which is one of the largest CEE-focused asset managers, says he does not expect a major pan-regional credit crunch, but certain countries will be particularly vulnerable. Those with a large Greek banking presence clearly fall into that category, which means primarily the Balkan countries where Greek banks have a market share of more than 20% (see chart: Greek banks market shares).

The other risk factors would be heavy dependence on external debt financing originating from the eurozone, and high loan-to-deposit (LTD) ratios among foreign-owned banks. The Slovak Republic, already integrated into the euro, has the highest proportion of external debt owed to eurozone external creditors, at 45% (see chart: External financing risk). But this is offset by one of the lowest LTDs in the region, at just 87%, which means foreign subsidiaries in the country have a large liquidity surplus.

Balkan states again feature prominently on the high-risk list based on these indicators. Serbia and Slovenia have relatively high LTDs, but lower external debt. The countries that are highly exposed on both risk indicators are Bulgaria and Croatia (although Greek banks are not active in Croatia), plus Ukraine.

The other country on everyone’s radar is Hungary. Foreign ownership of the banking sector is about 63%, but more importantly, the policy mix has become unsupportive during 2011. A tax of 0.5% on bank assets and the forced redenomination of Swiss franc mortgages into forints at an exchange rate unfavourable to the banks has heightened the losses for subsidiaries already affected by rising non-performing loans.

The 'Austrian Finish'

In fact, policy is becoming as much of a concern for many bankers in CEE as liquidity. Manfred Wimmer, Erste’s chief financial officer, says he originally hoped that Vienna 2.0 would not be necessary. But regulatory developments in recent months convinced him that something does need to be done.

“For the past 40 years, the core objective of European integration was to create a Europe-wide internal market, with free movement of people, goods and services, capital and liquidity. Today, we are seeing a trend to countries reverting back to giving a higher priority to their individual national interest. We do not yet have to say that the old paradigm has died, but the danger is that we are moving in that direction,” says Mr Wimmer.

If parent banks with very significant exposures to CEE cut those suddenly because of market concerns and balance sheet enhancing measures, it could lead to a systemic crisis in the region

Piroska Nagy

The source of much of that anxiety, ironically, sprang from Vienna itself. In November 2011, the Austrian National Bank (ANB) and Financial Market Authority announced a new set of measures to “strengthen business model sustainability” for Austrian banks operating in CEE. These included bringing forward Basel III capital requirements to 2013, with a potential buffer of up to 3% for systemically important institutions. More unusually, the ANB also placed a limit of 110% on the LTD ratio of any new lending in CEE subsidiaries.

In theory, this rule should be in keeping with the EBRD’s own efforts to encourage the development of local markets in CEE, which came out of the original Vienna Initiative. The LTD definitions are different from those used in regular accounting – stable funding is deemed to include not only deposits, but also local currency wholesale funding, and multilateral credit lines.

“With the idea of asking for more stable local funding, we implicitly support the wishes of the local authorities to promote their own capital markets. By concentrating on local markets, we should also reduce foreign currency lending,” says Andreas Ittner, the member of the Austrian National Bank governing board responsible for financial stability and bank supervision.

Central and eastern Europe – external financing risk (%)

The ANB also believes that most Austrian bank subsidiaries have already switched to more sustainable funding models as credit demand eased after the 2008 crisis. According to its calculations, at the start of 2008 the measures would have affected eight countries, with implications for more than 75% of Austrian subsidiary assets in five of them. By the end of 2009, only three countries would be affected – again, all in the Balkans, namely Slovenia, Croatia and Serbia. In the first two, at most 25% of assets would be affected, with Serbia the outlier at up to 50%.

There is a general consensus that the ANB’s measures will not have an immediate impact on credit extension. But Mr Wimmer warns that the LTD restriction "will eventually influence growth in various countries that do not have an adequate local deposit base. It should ultimately reduce the risks of boom and bust, but we will have to think about how best to use available funds".

Boris Vujcic, deputy governor of the Croatian National Bank, says it is this uncertainty about the long-term effects of such a restriction that causes concern.

“We have had more communication and assurances from Vienna ex-ante, but even so, the home and host supervisors will need to share information extensively, to monitor on a quarterly basis how this measure is implemented,” says Mr Vujcic.

Capital constraints

Perhaps Mr Ittner’s strongest line of defence is that the timeline for implementing ANB requirements is in any case more generous than the EBA’s mid-2012 deadline for banks to raise their capital adequacy ratios to 9%. Bankers agree he has a point – the EBA is causing them the most severe headaches in the short term.

In addition to the unseemly rush, there are also concerns over the details. One problem is the use of capital ratios, replacing earlier concepts of capital as a proportion of peripheral sovereign exposure. By using pure capital adequacy, there is a built-in incentive to deleverage rather than raising capital – especially after the difficulties encountered by UniCredit in its January 2012 rights issue.

The lack of linkage to sovereign exposure is also frustrating. Erste has already closed out a loss-making credit default swap portfolio in the third quarter of 2011, while Raiffeisen has only €440m peripheral eurozone sovereign exposure, none of it Greek.

“Despite this rather limited risk, we still have to raise capital adequacy. And it all comes at a time and with a speed that will distract management attention away from building business and assisting economies to grow after the last crisis in 2009. Many of the 71 banks [in the EBA survey] will be involved with some measure of reduction in risk-weighted assets,” says Mr Stepic.

We would not willingly withdraw from any of RBI’s existing CEE markets. It could happen only if we were forced out by regulatory measures

Herbert Stepic

He emphasises that RBI is not reviewing its CEE geographic footprint as part of this process. On the contrary, the events of the past year have borne out his long-held conviction that the risk/reward balance in CEE is more favourable than that in western Europe.

"We would not willingly withdraw from any of RBI’s existing CEE markets. It could happen only if we were forced out by regulatory measures,” he says, presumably with an eye on the situation in Hungary.

Too soon to say goodnight Vienna graph 3

Buyers wanted

But other banks are not in a position to stand by their CEE commitments. In Poland, Belgium’s KBC has announced the sale of Kredyt Bank to comply with EU state aid rules after its government bail-out during the financial crisis, and Portugal’s Millennium Bank has made clear its intention to sell. In Romania, Austria’s Volksbank needs to dispose of its subsidiary after selling the rest of its CEE network in 2011.

Greece’s ATE Bank, the only one to fail the EBA’s July 2011 stress test, intends to sell its Romanian subsidiary and its 20% stake in AIK Banka in Serbia. RBI signed a deal in early 2011 to purchase 70% of Polbank, the 350-branch Polish network of Greece’s Eurobank, for about €490m.

“But who is buying now?” says Mr Stepic. “I do not know a single banker in the region, after Basel III and the EBA, who has an appetite for considerations of market share.”

Some well-capitalised non-eurozone banks could step in to fill the breach. Russia’s Sberbank bought Volksbank International (VBI) in 2011, while Poland’s PKO Bank Polski lost out in a bid for its Polish peer Bank Zachodni WBK in 2010.

Sberbank’s chief financial officer Anton Karamzin says that “we do see opportunities for long-term growth in eastern Europe, and we believe that the acquisition of VBI gives us a good platform to start off with, together with maybe one or two smaller acquisitions in the region”.

Meanwhile, PKO’s chief executive Zbigniew Jagiello says he is already satisfied with the bank’s high organic growth rates.

“We were determined not to overbid for Bank Zachodni, and that strategy has been confirmed as valuations have fallen since then. Only if the price on a bank for sale is reasonable would we look at negotiations,” says Mr Jagiello.

In the absence of significant bidding from the private sector, multilaterals may be called on to help recapitalise CEE subsidiaries where parents are unable to intervene. As the crisis unfolded, the EBRD almost doubled its investments in its region of operation to around €9bn per year in 2010 and 2011. As a result, Ms Nagy says, it has already been investing at a crisis level since 2009, and could not go much further in terms of balance sheet capacity.

“What we can do is to reallocate some of our investments into equity rather than debt, and into the financial institutions that are worst hit by the eurozone crisis, such as in south-eastern Europe. We can also work smarter to coordinate with other multilaterals, since some of them have larger lending capacity, but do not have the same flexibility as us to invest equity,” she says.


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