Transcript of a Conference call on the Release of the Report on Deleveraging and Credit Monitor for Central and Eastern and Southeastern Europe

May 28, 2014

Washington, D.C.
Tuesday, May 27, 2014

Aasim Husain, Deputy Director, IMF European Department
Anna Ilyina, Advisor, IMF European Department
Jesmin Rahman, Deputy Chief, Emerging Economies Unit, IMF European Department
Debora Revoltella, Director, Economics Department, EIB
Piroska M. Nagy, Director, Country Strategy & Policy, Office of the Chief Economist, EBRD
Randa Elnagar, Communications Officer, IMF Communications Department

MS. ELNAGAR: Good morning. This is Randa Elnagar from the IMF's Communication's Department. Welcome to the conference call with media and analysts on Deleveraging and Credit Monitor for Central and Eastern and Southeastern Europe.

We have here staff from three international financial institutions that participate in the Vienna Initiative Steering Committee. Aasim Husain from the IMF European Department. Anna Ilyina, Advisor from the IMF European Department. Jesmin Rahman, Deputy Chief, Emerging Europe Unit, IMF European Department. Debora Revoltella, Director of the Economics' Department EIB. MS. Piroska Nagy, Director of Country Strategy and Policy in the Office of the Chief Economist of the EBRD.

Mr. Husain and Ms Rahman will go ahead and give some introductory remarks. The call, after the opening remarks, will open for questions. Both the call and the report are under embargo until 9:30 a.m. D.C. time. Thank you.

MR. HUSAIN: Thank you, Randa. This is Aasim Husain. Welcome to the call. This is the call on the latest quarterly report of the deleveraging and credit monitor which is prepared by the staff of the IMF, the European Investment Bank, and the EBRD.

This report is prepared under the auspices of the Vienna initiative which brings together banks, their regulators, both in their home countries, and in the countries in which they operate in Central Eastern and Southeastern Europe, the CESEE region, and also the international financial institutions.

The idea behind the deleveraging and the credit monitor is to keep close tabs on funding and credit situation in the banking systems in the CESEE region, and to provide an early warning in case the deleveraging process proceeds too fast or too far. In order for the Vienna Initiatives participants then to consider what actions, if needed, can be taken to counter such developments.

So today my colleague, Jesmin will talk about the latest situation on funding based on the recently released BIS data for the fourth quarter of 2013, and also about the latest information on credit developments in the region. Then our colleague, Debora, from the European Investment Bank will talk about the latest surveys of banks in the region.

Jesmin, over to you.

MS. RAHMAN: Thank you, Aasim. Good morning. This report covers developments until the fourth quarter of 2013. In the fourth quarter, BIS reporting banks continued to scale back their funding in the CESEE region. External position vis-à-vis all countries declined by 0.3 percent of GDP compared to 0.2 percent in the third quarter. So there was a very small pick-up in reduction in Q4.

Excluding Russia and Turkey, external position of BIS banks in Q4 also declined by 0.3 percent of GDP. We saw a pick-up in funding reduction to Russia, from 0.1 percent of GDP in Q3 to 1/2 percent of GDP in Q4 along with a pick-up in reduction in Hungary, Bulgaria, and Estonia.

In contrast, foreign banks increased funding to Turkey by 0.3 percent of GDP after a sizeable drop in Q3. Banks also continued to increase cross-border funding in Q4 to Czech Republic, Poland, and Ukraine.

When we take into account overall capital flows, funding availability improved in the CESEE region in the fourth quarter. Only four countries in the region experienced a reduction in both portfolio and cross-border bank flows compared to 9 countries in Q3.

Portfolio flows into the region, excluding Russia and Turkey, after becoming negative in Q3 saw a vigorous rebound in Q4. A number of sovereigns issued bonds in international market. The region's two largest economies, Russia and Turkey, saw a divergence in terms of net capital flows. Russia experienced large net outflows while net capital inflows almost doubled in Turkey relative to Q3.

Moving on to credit developments, overall credit growth outside Turkey and CIS remained negative in January 2014. Year-on-year nominal household credit growth to CESEE outside Turkey and CIS picked up slightly in January to 1.9 percent. This reflects some relaxation of lending standards for consumer credit and improving credit demand.

Credit to non-financial corporates outside Turkey and CIS, however, continued to contract in January, although at a slightly reduced pace than in December.

To look into factors behind credit developments I now hand over to our EIB colleague, Debora Revoltella, who will be discussing the outcome of the EIB's most recent credit survey.

MS. REVOLTELLA: Thank you very much. I think I will just go very quickly over the results of the bank lending survey. I have to mention that in the survey Russia and Turkey are excluded, so the survey is only covering the rest of Central and Southeastern Europe. In the survey we interview all the parent banks that are active in the region, and we also interview all the banks which operate in the region to understand, what is their take, on the last six months of the development and the next six months.

The survey was done with a cut-off date of end of March.

When we look at the main message of the survey, the most important point is the commitment of international banks to the region. But there is an element which is also very important and this is the factor that international banks operating in the region are becoming very selective according to different countries.

What they look at is the long-term potential of the market,their position in the market, and the expectation in terms of profitability corrected for the cost of risk. They are becoming more selective and defining their strategy in terms of a continual commitment to a certain market and less commitment to others. So we clearly see the leveraging coming in some countries, and continued commitment in others.

If we look at the condition in the local market, in terms of demand and supply, one interesting feature of the survey is the banks' expectation of an improving situation on the demand side. This is confirmed, also, from the past surveys.

Basically, what banks see is that constraints on the demand side are improving slightly faster than the constraints on the supply side.

If we ask the banks what are their constraints in terms of supply, two elements continue to stand out. One is NPL. What is important is that the banks consider a constraint to their capacity to lend both the NPL in the balance sheet of the subsidiary, and on the parent banks. So there seems to be something that needs to be done in terms of managing the NPL.

The second point that is also considered a constraint is regulation, in particular, the EU regulation and the change in regulation at the local level in some of the markets.

Funding is not considered to be a constraint to the supply of lending. Actually, the banks are telling that the funding situation seems to be easing on the market, and they have been moving from an internationally financed banking sector in the region into a domestically financed, with some banks also raising money on the capital market as was previously mentioned.

The question mark from a policy point of view is how much this is sustainable with stronger demand partners. It may be a very well sustainable situation in a period of very low demand for credit. But with demand slowly recovering this can become, again, a constraint.

The last point is on credit policy. As I was saying, NPLs are considered one of the stronger constraints to the capacity of banks to lend. When we ask the banks what is their expectation on development on NPLs they are telling us that they are getting closer to a peak in NPL, so it's still NPLs rising over time, but they are closer to a peak.

This analysis, I think, combined with the overall analysis on the deleveraging and credit monitor, leaves a couple of questions open, and these are the two policy issues that we analyzed.

On the one side, NPLs are serious constraints to the capacity of banks to lend, and something could be done in order to accelerate the development of a market for NPL, but also in general for creating the right incentive for banks to earlier address NPL issues.

The second point is on funding. Domestic funding might be sufficient in a moment of low demand, but for sustaining and accelerated part of the recovery in the region more has to be done in order to develop a domestic source of funding, particularly in the long term.

That's all on my side.

MS. ELNAGAR: Thank you very much. We're going to turn now to the questions.

QUESTIONER: Hello. I would like to ask you about the deleveraging in Hungary. Hungary was one of the countries last year that experienced one of the strongest outflows of foreign capital. This was 5.5 percent of GDP.

Do you see this as a positive or as a negative development for this country? What's the outlook for the region?

MS. NAGAR: Ms. Rahman is going to respond to this question.

Ms. Rahman: So yes, you are absolutely right. Hungary is one of the countries that have been affected the most by deleveraging, Cumulative deleveraging since the beginning, that is to say the beginning of the financial crisis, 2009 or late 2008, is close to 40 percent of GDP.

Is this good? Is this bad? You know, some of the deleveraging is a correction of excess in the past: a correction of debt overhang. But it's, of course, also taking a toll on credit growth and durable economic recovery. That would be my answer.

MS. NAGY: Can I add something from EBRD's perspective?

MS. ELNAGAR: Please go ahead.

MS. NAGY: Piroska Nagy from EBRD. I think the Hungarian story fits into what Deborah described, an increasing differentiation among countries that reflect, in part, perhaps increasingly, the domestic regulatory conditions.

It is well-known that Hungary has imposed early on a very high bank tax as part of the crisis tax system. This was supposed to have been phased out but it hasn't been. There have also been certain declarations by the government that have created a certain unease among banking sector participants in terms of a desired much higher share of Hungarian owned banks. There have been other measures for example trying to address a very significant issue, the so called foreign exchange denominated loans.

So there is an issue of a regulatory environment that also gives rise to higher deleveraging.

MS. REVOLTELLA: If I can add something. In this moment we are presenting the aggregate results of this survey to the banks, but we are also very close to releasing the country-by-country details. That will be available in one week’s time.

But what I can see is very much resembling what we have just said, what Piroska just said on the banking sector of the region. If we ask the international banks that are directed toward the market in Hungary, the international banks have a much worse assessment of the market potential and 63 percent say that the market potential is low in the country.

Also, they see their profitability as being more restrained compared to the profitability of their overall growth. There seems to be a negative approach of the banks compared to the market that is coming from the regulatory point of view. It's not a surprise.

If we look at the constraints for banks from the supply side, I think it's also important that they tend to be negative, again, on NPL. Clearly on local regulation, NPL is considered to be a constraint to supply, to both the domestic and also international. But also the change in local regulation is considered to be a negative factor.

Another factor that is considered to be a constraint to supply is the local banking outlook. So it's that perception of, again, the market potential in the country.

MS. ELNAGAR: Thank you. Any other questions?

QUESTIONER: Hello. Good morning. A couple of questions, if you don't mind. First of all, in the EIB survey or in any other contact with lenders in preparation for this, did you discuss the role that the, as quality review and stress tests, within the European sort of regulatory framework were playing in deleveraging plans for this year?

Given that, would you have any expectation that when those are out of the way the rate of deleveraging might slow slightly or even at some point next year or the year afterwards stop?

My second question is a refrain on the, sort of, unanswerable impact on Russia/Ukraine. Did any of your contact with the banking groups sort of overlap with signs that the takeover of the Crimea peninsula was going to lead to the sort of situation that we're in now, and what kind of impact that might have on the planning of European bank groups active in the region? Thanks.

MS. ELNAGAR: Mr. Husain is going to take this question.

MR. HUSAIN: Let me start off and then, perhaps, Debora can add in the context of the survey.

So first on your second question, the impact of Russia and Ukraine, the data that underlined the latest deleveraging and credit monitor, of course, go through the end of 2013 for the bank funding side. For credit, and for some countries, we have information for the early part of 2014. But for the most part, the data do not cover the span or the period when geopolitical tensions really did flare up. So, of course, we will not see this in the data.

More broadly though, in terms of what the impact could be, of course, it's early days still to be able to assess empirically. It's clearly a risk that needs to be kept on the radar screen. So far there has been not a lot of anecdotal evidence or pick-up in terms of the direct impact on bank's balance sheets or on bank's funding situation.

But it's clearly something that needs to be watched in the quarters ahead. Whether large international banks, if they book lower profits in their Russia and Ukraine operations would that affect their ability to fund their operations elsewhere in the region?

Now, this goes also to your first question, which is what would be the impact of the asset quality review and stress test by the ECB that are coming later in the year? There too, of course, it would be impossible to see in the data at this stage. But a risk or a situation that clearly needs to be monitored closely.

So banks, indeed, have indicated that in order to build up their capital buffers they will be looking on the asset side of their balance sheet. But whether this will translate into significant deleveraging of their assets or their funding to their CESEE subsidiaries remains to be seen.

In fact, to the extent that the asset quality review opens up funding markets for banks it could actually lead to the reverse. More funding for those banks for their operations in CESEE.

So these are risks clearly worth watching going forward. It is early days to see their effects in the data. I should mention that we recently released a regional economic issues report by the IMF, three or four weeks ago, which looks at external funding risks, and precisely these types of risks, and also risks related to what happens in global financial markets as a result of tighter than envisaged tightening by the U.S. Fed.

So I would refer you to that in case you're interested. I think if Debora now would like to add?

MS. REVOLTELLA: Yes. What I can add, I think these are very much a concern: the asset quality review and the stress tests. They are clearly a risk for the banking sector in the sense that there may be some issues coming.

But on the other side, they also have the potential for substantially stabilizing the market, and I think a much easier access to funding following the asset quality review and the stress test. Also, I think addressing the issue of capitalization of all the parents, if ever there would be any need for that, may finish deleveraging.

If we look at the survey, per say, and if we believe what the bank is telling. In the deleveraging and credit monitor we have on Page 6, we have asked the banks what do they expect for the last six months and the next six months in terms of their total exposure to Central Europe and Southeastern Europe.

We see that there is not much difference in what they say in the past and in the future. Actually, there is some more positive going forward with some of the banks saying they may consider expanding exposure.

But the interesting part of this picture is the fact that more or less we see that all the banks that have a reduced exposure, their reduction has mostly been via inter-group funding rather than the capital. So this is an interesting point.

MS. NAGY: I'd like to add two points. Very much again, in line with what my colleagues from the IMF and the EIB have said.

One of the positive aspects of the asset quality review, among others, is that it is leading to a stronger appreciation of the problem of NPLs, non-performing loans on balance sheets. It almost forces both the regulators and the banks to face up to this problem which is, as the EIB survey shows, actually is an issue both at the parent level and the subsidiary level, and which is the main constraints, as banks see, in the way of future credit growth.

So dealing with the NPLs, we expect this to move much higher to the policy agenda than it has been, and some much more proactive action by both the banks and regulators in the coming months.

On Russia and Ukraine, as we know, basically all major foreign non-Russian bank groups have closed their branches in Crimea. Even one Russian bank, my information is that Alfabank, has also closed its branch in Crimea.

So those banks which actually would like also to operate in Ukraine at this point, have decided not to operate in Crimea. The big question will be the situation in Eastern Ukraine. We'll see how the situation unfolds. Hopefully it will stabilize, so that the issue goes away.

We have not seen a major impact on Russia itself, will all major banks at this point not changing their future strategy in the country.

MS. ELNAGAR: Thank you. Other questions?

Thank you very much. As mentioned earlier, we are going to post a transcript for this call. The call and the report are under embargo until 9:30 a.m. D.C. time. Thank you very much.

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