Post-crisis bank business models in Central and Southeastern Europe. Erik Berglof Chief Economist European Bank for Reconstruction and Development

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1 Post-crisis bank business models in Central and Southeastern Europe Erik Berglof Chief Economist European Bank for Reconstruction and Development

2 The region at the peak of the crisis: Strong impact, but considerable variation Criteria: (1) > 25% depreciation of currency; (2) > 2% house price decline; (3) > 2 (out of 6) months of industrial production decline; (4) > 2 consecutive months net credit decline

3 Could have been a lot worse No uncontrolled currency collapses No system wide bank runs; payments systems intact No populist or coercive policy responses No reform reversals On all these dimensions, this crisis contrasts with previous emerging market crises

4 Capital outflows relatively modest in most countries in Central and Eastern Europe Per cent 15 Percentage changes in external assets of BIS-reporting banks Avg 27Q4/28Q1 Avg 28Q4/29Q Emerging Europe (excl. UKR, RUS) Emerging Russia & Cent CA and Asia Latin Latin America Emerging Emerging Asia Europe Ukraine Caucasus America Asia

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6 Crisis challenge: Systemic problem systemic response

7 Forceful crisis response Massive domestic support in western Europe Mature responses in central and eastern Europe Forceful, coordinated international support IMF resources tripled to US$ 75 billion EU BoP support quadrupled to 5 billion G2: capital to multilateral development banks ECB liquidity support to Western banks Parent banks stayed in the game

8 8. The crisis response included large international support packages External balance of payments support (Percent of GDP) Q Q Q Q Q Q4 28 Q1 29 Q2 29 Q3 29 Korea Thailand Philippines Indonesia Hungary Latvia Romania Ukraine

9 and an unusual mechanism for publicprivate coordination: the Vienna Initiative Coordination among banks to maintain exposures Joint IFI (EBRD/EIB/WB) support to bank groups Home country authorities allow parent bank support of subsidiaries Host country authorities to provide liquidity equally to foreign and domestic owned banks

10 Financial integration a double-edged sword Capital inflows and financial integration key drivers of growth and convergence Foreign banks were a stabilising factor in the crisis However, foreign financing also contributed to credit booms, excess leverage, and foreign currency debt that made the crisis worse

11 Capital inflows were a driver of growth in transition countries in contrast with other emerging markets Non-transition sample Transition sample Growth GDP per cap, PPP (av ) y =.1681x R 2 = CA/GDP, % (av ) Growth GDP per cap, PPP (av ) y = x R 2 = CA/GDP, % (av ) Analysis suggests a causal relationship

12 However, foreign finance led to FX lending, credit booms, and external (over-)indebtedness Cross-border debt inflows and domestic credit growth, 25-8 Foreign bank share and FX lending share, end-27 Median growth of BIS lending between mid- 25 and mid-27, % ALB EST LIT SER RUS TAJ BUL FYR BiH HRV SLV POL CZE HUN AZE KAZ ROM MOL UKR R 2 = LAT Average credit growth between mid-25 and mid-27, % Share of foreign currency lending in total domestic lending, % AZE TUR RUS MOL SLV UKR KAZ ARM HUN LAT SER ALB HRV FYR LIT BUL Asset share of foreign-owned banks, % POL EST

13 which made the crisis worse External debt and cumulative output decline in crisis Pre-crisis credit boom and cumulative output decline in crisis Output growth over Q4/8- Q1/9, qoq, s.a Alb Pol BiH Geo FYRM Kaz Kyr Bel Ser Hun Azer Cze Ro Bul Taj Cro Slk Ru Mol Sln Tky Lit Est Arm Ukr External debt in percent of GDP, 27 Lat Output growth over Q4/8- Q1/9, qoq, s.a BiH Pol Geo Alb Kgz Kaz FYR Aze Srb Blr Taj Hrv Cze Hun Svk Rom Mol Tur Arm Rus Bgr Ltu Svn Lva Ukr Est Mne Private credit growth,

14 Cross-border banking requires supporting regulatory framework Home country model not sufficient Requires check at the European level Host country authorities need assurances How to deal with non-eu countries Higher capital requirements Too complex to fail (to manage)? Living wills How to cut? Return of securitisation?

15 Vienna Plus: Addressing the FX exposures Together with the other IFIs: Ensure conducive macroeconomic policies Establish supporting regulatory framework EBRD: Actively use own funding activities Work with partner banks to reduce FX exposures

16 Thank you!