Transcript of a Conference Call on the Launch of the IMF’s New Series "Central, Eastern and Southeastern Europe—Regional Economic Issues”
Prague, Czech Republic
Thursday, April 25, 2013
Aasim Husain, Deputy Director, European Department
Bas Bakker, Chief in the Emerging Economies Division of the European Department
Christoph Klingen Deputy Chief in the Emerging Economies Division of the European Department
Silvia Zucchini, External Relations Department
MS. ZUCCHINI: Good afternoon to the journalists in the room and to those connected in conference call from the United States or elsewhere internationally. Welcome to the briefing on a new IMF series entitled “Central, Eastern and Southeastern Europe—Regional Economic Issues”. My name is Silvia Zucchini and I am from IMF Media Relations.
The report that you have in front of you is the first in a series that we will launch tomorrow. This series is the CESEE REI and will be a periodic publication that will focus on topical issues facing the economies of the region. This first issue analyzes the evolving role of the banking system in financing growth in Central, Eastern and Southeastern Europe. The report has been prepared by a staff team of the IMF's European department for a conference on this topic that will be held here at the Czech National Bank Conference Center tomorrow.
For those in Prague, you are invited to attend the highlight of the conference, the panel discussion on the Future of Banking in CESEE with Governors Singer, Belka, and Novotny, Peter Tils of Deutschebank, and Reza Moghadam, the Director of the IMF's European Department. Today's briefing is an opportunity to discuss the report in advance of its publication tomorrow. We have here two of the main authors, Bas Bakker and Christoph Klingen, and they will be happy to answer questions and elaborate further following an introduction by Aasim Husain, the Deputy Director in the European Department and supervisor of the report. Aasim, you have the floor. Thank you.
MR. HUSAIN: Thank you very much, Silvia. As you know, foreign banks have come to play a major role in almost all of the Central, Eastern and Southeastern economies' banking systems over the last decade. When state-owned banks were privatized to strategic foreign investors in the early stages of transition, it was mainly Western European banks that took a dominant role and dominant ownership. The credit boom of the mid-2000s made many of these foreign banks providers of large-scale funding to the region, though not everywhere, for example, not in the Czech Republic.
This banking paradigm has served the region well, but with the global financial crisis, important drawbacks have also become apparent. For this reason the paradigm is now evolving, it's now shifting, and regulatory changes and market pressures are adding further impetus. Funding is shifting toward greater reliance on local sources such as domestic deposits. In contrast, foreign ownership of the Central, Eastern and Southeastern economies' banking systems remains robust. Where occasionally foreign banks have sought to exit specific markets, other foreign banks have been ready to enter.
In this report, we find clear benefits of wide-spread foreign bank presence in CESEE. With the arrival of foreign banks, the incidence of banking crises for example fell sharply. Banking practices and governance improved. Banks became more resilient to local shocks and households' and firms' access to credit improved dramatically.
However, even though the presence of foreign banks was overall very beneficial, the management of their funding models did exacerbate boom-bust cycles in many countries. In principle, foreign funding can improve the efficiency of the international allocation of credit and also improve the diversification of risk. However, the experience the Central, Eastern and Southeastern Europe clearly shows that such benefits can be undone by exposing economies to large swings in funding from foreign banks. When such funding is plentiful, it facilitates extended economic booms as it did in the region during the mid-2000s. But when funding dries up suddenly, as it did during the global crisis, it can precipitate a very deep recession as it did in many countries in the region. For the cycle as a whole, what we find in the study, and this covers both the boom and the subsequent bust, is that the availability and the sudden subsequent drop in foreign funding did not result in higher economic growth on average. In other words, there was higher volatility but no growth dividend.
Against this background, the recent post-global crisis trend that's already underway toward less reliance on foreign funding—and therefore also its associated volatility—is actually welcome. However, the process should go neither too fast nor too far. Otherwise, it risks crimping credit provision and economic recovery. One would also lose the benefits of financial integration if this were to go too far or too fast. Obviously financial autarky is not a good thing.
Policymakers can facilitate an orderly transition toward a more stable funding model that relies less on foreign funding. How can this be done? By pushing ahead for example with establishing the envisaged integrated European financial architecture that would reduce swings in the availability of foreign funding to banks and thereby make the need to transition to less foreign funding less necessary.
Similarly, improved cooperation between home and host country supervisors more generally would help better manage cross-border banking and would make the shift to a new banking funding paradigm less urgent. More coordinated use of macroprudential policies by home and host supervisors would make such policies more effective and would also help banks better manage volatility in funding.
Moreover, policymakers can also at least partly offset the economic headwinds that come from foreign banks reducing reliance on funding from overseas and from parents by removing obstacles to credit growth. For example, tackling what in many countries are still very high nonperforming loan (NPL) ratios would make banks less reluctant to provide new loans, and facilitating local capital market development would open up alternative ways to finance investment thereby countering any headwind that would come from banks transitioning to less foreign funding.
That's all I have by way of introduction. I think my colleagues are ready to answer any questions.
QUESTION: My first question has to do with the possibility of the authorities coming in and helping out. The first one is how do you tackle high NPLs and how do you facilitate local market development which has been an issue for the past 20 years but especially since everything has really declined in the past 10 years in terms of global market participation. So what makes the situation different or is it just the repeated call—one of the many calls—made by the Vienna Initiative for example and their constituents. And with the NPL levels, what exactly do you recommend authorities should do, considering that all the banks are telling us is that the reason they're going so slowly on provisioning is that they can't handle the NPLs and they need financing from somewhere else. So are you suggesting that the regulatory authorities force banks into share issues and other recapitalization techniques as they will have to take the hit?
MR. KLINGEN: Thank you. I can take the question on nonperforming loans and what to do about them. First of all, as you point out, the region is very heterogeneous in terms of many things as we highlighted in the report, big difference for instance in terms of NPLs. In the Czech Republic, for instance, NPLs are a very different story than in Albania. But, on average, NPLs are a problem mainly related to the strong boom credit that the countries had in the mid-2000s. That credit boom cannot be undone and the legacy is there.
I think what is straightforward to do is to eliminate the many obstacles to that stand in the way of NPL resolution. Actually, in the context, of the Vienna Initiative we have done a report and we have systemically listed all these obstacles that are still there in the regulatory area, in the tax area, and so on and so forth.
We also have looked at the implications of NPL resolution on bank capitalization. They would be manageable in most cases and countries could be more aggressive in resolving NPLs. Finally, we highlighted that there might be a problem of coordination in resolving NPLs. Nobody wants to go first because if you go first it makes you look bad vis-à-vis your competitors. Also if you go first you don't take into account the positive externalities that you have on the economy as a whole by cleaning up NPLs. So some sort of coordination in moving forward and pushing the process along would be beneficial. Of course, we don't want to go too far and have an overly heavy-handed intervention by the governments, but some coordination going forward would be useful.
QUESTION: So you're suggesting that regulatory authorities should push aggressively to encourage banks to tackle NPLs?
MR. KLINGEN: We are not overly prescriptive about what exact mechanism should be set up. What we are saying is that there should be some coordination, somebody could take the lead. It's not necessarily the regulatory authorities. It doesn't necessarily need to be a government entity either. You could also think about cases where bankers' associations take the lead. All of this is to say that indeed we want to push this coordination forward but, on the other hand, we won’t be too heavy-handed and directly intervene into in private sector contracts.
MR. HUSAIN: On the NPL issue let me add that, while it could be the case that in some countries regulators could take more aggressive action, I think Christoph's point is that there are also plenty of other obstacles that need to be addressed. Those obstacles vary across countries and their removal would actually facilitate NPL resolution. For example, obstacles in some countries have to do with the legal system, how quickly you can seize collateral from borrowers that are not performing on their loans. In other places, for examples, rules on collateral execution may be problematic. In some countries, tax treatment of provisions is unfavorable. So there are differences across countries and the appropriate tool to deal with the obstacles would vary.
MR. BAKKER: As per your observation that it’s not the first time that the IMF has called for the development of local capital markets, you are correct. But you have to take into account that a few things have changed since the crisis.
Before the crisis, domestic saving in most countries was far less than domestic investment so there was a large gap between the two, which was filled with capital flows from abroad. So you needed foreign capital to finance domestic investment. Since the crisis, current account deficits in most countries have come down significantly, most dramatically so in countries that had huge current account deficits previously, such as. Bulgaria and the Baltic Countries, for instance, show us increasingly that it's possible to finance investment domestically. That can happen in two ways. First, by banks. In the future, to a much larger extent, domestic deposits could fund domestic credit growth and domestic investment. But second also, by the development of local capital markets that would make it, for instance, possible for larger firms to issue corporate bonds domestically and, ideally, in local currency instead of issuing them abroad.
Of course, there is also a large diversity in the region. Countries like Poland already have a fairly well-developed local capital market while in other countries this is much less so. So having a local capital market would provide another source of local funding that would both make it easier for firms to attract funding and also—to the extent that firms would be able to attract funding in the local capital market—it would leave more room for the banks to lend to other creditors.
QUESTION: I have a question regarding the banks in Central and Eastern Europe. They complain, especially the Austrian banks, that there are different regulatory conditions in the countries in the region. Basically one country would set a limit on dividends, another country would set a limit on how much cash the banks can transfer between their branches in other countries. Do you think there should be a unified system in the region?
MR. KLINGEN: There's certainly a case to be made for greater harmonization of regulatory and supervisory practices. To some extent, if harmonization of the European system goes ahead as we move toward a banking union, CESEE countries that opt into the banking union would automatically be part of the harmonization that you are looking for. To some extent this will be taken care of in that context.
MR. HUSAIN: I think the question is whether regulatory differences across countries pose a problem. The simple answer to that is that differences in regulations across countries do make bank funding more volatile and when those regulations change then bank funding responds to those changes. If there is greater uniformity of regulations across countries, then volatility of global flows, and bank funding, in particular, would diminish. In fact, that type of reasoning is what is behind our recommendation for improved home- and host-supervisor cooperation, which would improve or lessen the swings in cross-border funding that make it less desirable than local funding.
MR. BAKKER: There's a concern that regulators in home countries and host countries would take regulatory measures that would hurt each other. Indeed, this is one of the reasons why in early 2012 the Vienna Initiative was re-launched. In particular, it was to have a discussion platform where home and host supervisors would come together and not take measures that might be good from their individual perspective but where—if the other would take similar actions—you would end up with a situation where everyone was worse off. And the Vienna Initiative has been quite successful. Since it was launched, we have seen that the reduction in cross-border funding has diminished significantly.
QUESTION: I have one more question. Concerning NPL levels and regulation in general, just from our discussions, and most of these are background discussions with bankers across the region, we are hearing reports that the region’s banks have significantly higher NPLs than they are reporting to authorities, in some cases we're hearing that the authorities are aware of this. They know that they have to be a little bit lenient because there’s not enough cash for the bank to take losses and then have to recapitalize themselves. It's like one of the stress test situations that we see in Western Europe where the requirements of the stress test may not have been as rigorous as was later needed when they were repeated. So my question is in your compiling of this report how did you feel about the official statistics in terms of the health of the banking sector? Do you think that, as these banks are saying, NPLs are topping out at about 20 percent? Or do you think that there should be more rigorous investigations into specific factors of specific banks in specific countries?
MR. KLINGEN: When we look into this in more detail, there is a lot of heterogeneity across countries and also differences in how NPLs are defined. This is not only an issue in the CESEE, it's an issue all over the world, including across Western Europe where country A and B may have different practices. So it's very difficult to compare numbers across countries.
We have heard here that NPLs may be understated in some instances. However, it's very difficult to say how systematic that really is the case and, to the extent that it takes place, how large it is. It is true that typically in all countries it takes a little bit longer for the full extent of the problem to be recognized, so NPL statistics are revised sometimes up. On the positive side I would leave you with the statement that capitalization of the banks in the region is relatively sound. So even if things were underestimated to some extent it doesn't really undermine the fact that overall capitalization is relatively comfortable in the region. We see that the NPL numbers that are reported are very high in some countries and clearly something needs to be done about that.
QUESTION: Are you comfortable with the capitalization numbers? There is an example of—Bulgaria’s banking sector for example which as you know mostly has privately held banks, it’s very difficult to see the individual performance of an individual bank’s loan book because it’s only seen by the bank’s auditors most times. But the most recent merger that happened with this BACB which Ally Irish sold to a local group, it had a tier I capital ratio of about 20 percent and they sold the bank after buying it for 250 million euros, they sold their stake in it for 100,000 euros. So this raises the question, core tier I capital, is that an accurate figure?
MR. HUSAIN: Let me jump in on this one. Our study does not attempt to assess the financial health of the region or of any country. Let's be clear on that from the outset. Instead we're looking at trends in bank funding and in banking models and how that is changing in response to the global financial crisis. What you say about high NPLs is actually right. In many countries in the region NPL levels are much higher than they have been certainly pre-crisis. But in many respects that is not a surprise. Once a country gets hit with such a major economic downtown, NPL ratios will increase, as they have. So it's not a big surprise. In some countries I think it's pretty clear that those ratios have not peaked. They're continuing to rise. They're well into double digits and they'll rise further.
What is interesting rather is that, almost without exception, financial crises have been avoided throughout the region and this is despite very major downturns. And this is despite very major pullbacks in foreign funding. Whether it's the high capitalization levels that they started out with, whether it's other factors and so on, banks have generally been resilient. That does not speak to whether they will remain as strong, but I think it does give some comfort.
MR. BAKKER: To add to this, in the report on page 31 we have a chart on profitability of Western bank operations in CESEE, which shows that while profitability has declined both before and after the crisis, it remains much higher than in Western Europe. But you also see that in CESEE by and large plain vanilla banking we have problem; we have a credit boom. After the credit boom ended many loans became nonperforming but the portfolios of the banks are pretty simple. And Eastern Europe has had tremendous credit booms and given the near absence of banking crises since 2008 is quite telling if you compare it with Western Europe, where we have seen a much larger number of banking problems. So there are higher capitalization of the banks, capital adequacy ratios that were much higher and much simpler bank portfolios probably both contributed and the region is by and large still very profitable.
Of course there are differences across countries, but that's also why ownership in the region has not declined too much. It was an attractive region for Western banks and it remains an attractive region. There was a concern in 2008 when Western banks came under funding pressure that they would certainly withdraw from Eastern Europe. They have not done that. They stopped increasing their funding and they even have reduced it somewhat, but they have stayed in the region and most banks consider the countries in Eastern Europe as part of their core area and they are planning to stay there.