Lost & Found in Eastern Europe: Replacing Funding by Western Europe's Banks

IMF Blog, June 13, 2012

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With Western Europe’s banks under pressure, parent-bank funding for subsidiaries in emerging Europe is no longer guaranteed.
Parent bank deleveraging—selling off assets, raising capital, and reducing loans, including to their subsidiaries—need not translate into a reduction of bank credit in emerging Europe if other funding sources fill the gap.
A credit crunch can be avoided as long as parent banks reduce exposures gradually and domestic deposits, other banks, and local financial markets replace the withdrawn funding.

Ownership
- Foreign banks control more than half of the banking systems in most of Central, Eastern, and Southeastern Europe.
- Their share exceeds 80 percent in Bosnia, the Czech Republic, Croatia, Estonia, Romania, and Slovakia.
- Only in Russia, Ukraine, Belarus, Moldova, Slovenia, and Turkey do they not dominate.
Funding
- Foreign banks have lent up to 60 percent of GDP to countries in the region.
- The average stands at 27 percent of GDP.
- Roughly half of it is to banks, and direct cross-border lending to households and firms accounts for the rest.
Historical impact
- When western banks were abundant with funding before the crisis, they bankrolled much of the region’s credit-driven domestic demand boom (with exceptions such as the Czech Republic).
- When the global economic crisis hit in 2008, funding for the region came to an abrupt halt, and most countries fell into deep recessions.

Context
- Western banks were under intense funding pressures before the European Central Bank provided relief by launching its 3-year refinancing operations.
Observed changes
- Western banks reduced their funding to banks in the region by 8 percent.
- During the same period, banks in Eastern Europe managed to attract substantial additional domestic deposits.
- Combined funding from both sources still grew in almost all countries, with the notable exceptions of Slovenia and Hungary.

Promote stable domestic financial systems so depositors continue to entrust savings to banks that intermediate them effectively.
Maintain high standards for liquidity and capitalization.
Sort out nonperforming loans, which are still high in much of the region.
Develop additional funding sources, for example by promoting local currency financial markets.
Prepare for an escalation of financial tensions at home or abroad by upgrading frameworks for emergency support and bank resolution, and ensuring they would work smoothly in practice.
Implement contingency planning, tight monitoring of banks, and close coordination between financial supervisors in the banks’ home and host countries.

Ensure deleveraging remains orderly; sudden large-scale exposure reductions of foreign banks would be difficult to compensate and would pose challenges for the balance of payments.
Home and host country bank supervisors should work together if a cross-border bank needs support or must be resolved.
Supervisors should keep each others’ interest in mind and avoid sudden and unilateral actions with adverse consequences for the other.
The Vienna 2.0 initiative reflects efforts by officials, bankers, and regulators to improve coordination.
Some gradual and orderly deleveraging of western parent banks could be beneficial by reducing the still high external debt in many countries—but "orderly" and "gradual" are essential.

Foreign banks control more than half of the banking systems in most of Central, Eastern, and Southeastern Europe.
Their share exceeds 80 percent in Bosnia, the Czech Republic, Croatia, Estonia, Romania, and Slovakia.
Only in Russia, Ukraine, Belarus, Moldova, Slovenia, and Turkey do they not dominate.
Foreign banks have lent up to 60 percent of GDP to countries in the region.
The average stands at 27 percent of GDP.
Roughly half of it is to banks, and direct cross-border lending to households and firms accounts for the rest.
Western banks reduced their funding to banks in the region by 8 percent in the second half of 2011.
The European Central Bank launched its 3-year refinancing operations in that period.
Exceptions where combined funding did not grow: Slovenia and Hungary.
Nonperforming loans remain high in much of the region.
Initiative name: Vienna 2.0.

Source: Lost & Found in Eastern Europe: Replacing Funding by Western Europe's Banks — Christoph Kling, June 13, 2012