The Evolving Role of the Banking Systems in Central, Eastern and Southeastern Europe

IMF Blog, May 9, 2013

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In the 1990s, there were very few foreign banks; state-owned banks were dominant and many countries experienced severe banking crises.
When banking systems opened to foreign investors, foreign ownership quickly became prevalent (Figure 1).
After foreign entry, the incidence of banking crises dropped dramatically; where crises still occurred they were usually the result of failing domestic banks—not foreign-owned banks.

During the mid 2000s, foreign banks fueled and financed large domestic demand booms in many countries.
Foreign banks had access to large amounts of foreign funding (Figure 2), mostly from their parent banks in Western Europe, which were tapping wholesale funding markets.
Foreign banks used this funding to expand credit where demand and profits were highest; countries with bright growth prospects and relatively low credit penetration were attractive lending destinations.
The resulting booms were extraordinary in many countries.

When the global crisis hit in 2008, new parent funding dried up and much of the previous inflows reversed, triggering deep recessions.
The larger the inflows during the boom years, the larger have been the outflows since 2008 (Figure 3), and the sharper the economic contraction (Figure 4).
Since late 2008, parent banks have been scaling back funding of their subsidiaries; subsidiaries are increasingly relying on domestic deposit funding.
Over time, greater reliance on retail deposits should help reduce boom-bust cycles because retail deposits tend to be more stable, but the pace and extent of the shift must be monitored to avoid risks from moving "too fast nor too far."

Establish a banking union to facilitate home-host supervisory cooperation.
Coordinate macroprudential policies more closely to reduce the magnitude—and possibly the likelihood—of future credit cycles.
Tackle nonperforming loans, which in many countries remain very high.
Develop local capital markets as an alternative source of investment finance to offset headwinds from less plentiful foreign funding.

IMF blog post by Reza Moghadam, May 9, 2013.