The solid performance of CEE. Central and Eastern Europe pulled along by banks

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1 The opening of the credit sector to outside investors has been a key part of the process of transforming and modernising the entire area and its economy. Western banks now play a leading role in many countries, except Turkey, Russia and Ukraine, where consolidation is still ongoing. Slovenia is the only country in which the State continues to play a significant role in the sector. There are certainly few international level players, but they are very active. Central and Eastern Europe pulled along by banks EUROPE 2 by Fabio Mucci, Debora Revoltella Corbis The solid performance of CEE economies 1, with stable growth environment and lowering of risks, continue to support strong growth of banking activity at the regional level has been another year of extraordinary growth especially on the lending side, with total loans over GDP climbing to 42% of GDP from 37% one year earlier (up by 33% yoy). Growth was significant also on the deposit side, with deposits over GDP increasing from 39% to 40%, with a yoy growth of 21 per cent. Despite this accelerated growth, banking sectors in the CEE region remain quite modest compared to that of Eurozone countries. The entire regional banking sector comprises 2,600 banks, with total assets of approximately EUR 1.4bn. This corresponds to roughly 5.6% of the consolidated 35

2 CENTRAL AND EASTERN EUROPE PULLED ALONG BY BANKS balance sheet of all banks in the Euro area. From a structural point of view, the banking market continues to be dominated by large international banks, with strong commitment to the region, being long-term investors with a clearly defined positioning strategy. At the end of 2006, international banks market share further increased on the back of new privatisations wave in SEE countries 2, climbing to 82% from 78% in 2005 (excluding Russia, Turkey and Ukraine). With only few privatisations opportunities remaining in established CEE countries, the focus of international investors is gradually moving Eastward targeting markets such as Russia, Ukraine, Georgia and Kazakhstan where potential targets remain more readily available. The opening up of the domestic banking to foreign investors has been a key features in the transformation of CEE banking sector. Although international banks have nowadays achieved a dominant position all over the region, structural transformation is still ongoing in Turkey, Ukraine and Russia, where the share of international banks appear to be the lowest in the region and further market consolidation should also be expected. Among new EU member States, Slovenia emerges with the lowest share, with State still controlling roughly 23% of the domestic banking assets. This is fully connected to the late removal of entry barriers and one of the two biggest banks not being privatised yet. By contrast, the dominance of foreign banks is the highest in the case of Estonia and Slovakia, where almost 100% of banking market assets are in the hands of large international players. Those shares are in any case well-above the average Euro area level, where foreign ownership stands at 16 per cent. On a more general perspective, international players in the market will continue to play a significant role, targeting the region as a market for growth and possibly gradually expanding towards new developing regions. We expect some possible transformation in the landscape to be related to ongoing concentration at the domestic level. More importantly, as only three among the leading international groups in the market are significant players in the 1. STRUCTURAL INDICATORS OF BANKING SECTOR IN THE CEE COUNTRIES 2006 no. of banks Branches Banking Market share Total Gross Asset Total loans+deposits per mn penetration 1) inhabitants Foreign CR5 bln % GDP bin % GDP banks Poland % 70% 46% Hungary % 95% 54% Czech R % 96% 63% Slovakia % 98% 67% Slovenia 22 (2) 345 (2) 99% (2) 35% (2,5) 62% Estonia 11 (2) 171 (2) N.A. 99% (2) 98% Latvia N.A. 57% 69% Lithuania 78 (2) 203 N.A. 90% (5) 82% Bulgaria % 81% 50% Romania % 89% 62% Croatia (3) 85% 91% 73% Serbia % 79% 47% Bosnia % 76% (5) 68% Turkey % 24% 62% Russia 1, % 8% 42% Ukraine (4) 69% 31% 35% CEE Total 2, % 48% 54% 1, , Euro area 6,308 (2) 540 (2) 98% (6) 16% 43% (2) 24, , Note: 1) Population aged 15+ having a banking relationship with a bank; 2) As of 2005; 3) As of H1 2006; 4) As of May 2007; 5) On share capital; 6) Refer to Austria Source: UniCredit New Europe Research Network, BA-CA Market Research and ECB

3 EUROPE 2 European arena, concentration in the market could also be imported, as a consequence of wider scope cross-border M&As at the Western European level. Few international players very active in the region All banking systems in the CEE region are today characterised by sound, modern and dynamic players, in a context of lively competitive pressures. A few international players consider the region as a second home market for growth, controlling roughly 26% of the entire banking assets in the region at the end of last year. Among the largest international banks operating in the region, UniCredit Group, operating through BA-CA in CEE, emerges as undisputed leader with a total assets of EUR 109 billion 3 and net profits after taxes (before minority interests) of EUR 1.7 billion 3, being more than twice as large as the nearest competitor in terms of this latter indicator. Erste Group ranks second with a total assets of EUR 61.5 billion 4 and net profits after taxes (before minority interests) of EUR 805 million 3. Raiffeisen International comes at the third place with total assets of EUR 55.9 billion and net profits after taxes (before minority interests) of EUR 686 million. All these players profit from a widespread cross-regional network. UniCredit still show the strongest positioning at the regional level being present in 20 countries, recently strengthened by the announced plans to acquire the majority shareholding of the third largest Kazakh bank, ATF Bank, and the fourth largest bank in Ukraine, Ukrsotsbank. Raiffeisen International and Société Générale follow with a network of 15 countries. This latter has been particularly active in the recent months, being involved in several M&As operations in the region, enriching its network by five new markets (Albania, Croatia, Macedonia, Moldova and Georgia). Good macroeconomic conditions continue to support strong banking activity The favourable economic cycle continue to drive a significant expansion in banking activity at the regional level. Buoyant growth in consumption on the back of household s desired fast convergence to international living 2. TOP INTERNATIONAL PLAYERS IN THE CEE REGION CONSOLIDATED ASSETS NET PROFIT COUNTRIES OF PRESENCE iii ( BNL) i ( MN) ii UNICREDIT UNICREDIT 1,744 1 UNICREDIT 20 1 ERSTE BANK 62 ERSTE BANK ERSTE BANK 7 RZB 56 RZB RZB SOCIETE GENERALE 41 SOCIETE GENERALE SOCIETE GENERALE 15 INTESA SANPAOLO 30 5 INTESA SANPAOLO INTESA SANPAOLO 10 OTPBANK 29 OTPBANK OTPBANK 9 Note: i) 100% of total assets, revenues and profit after tax (before min. interests) for controlled Companies (stake > 50%) and share owned for non controlled companies; pro-forma results include also banks acquired during 2006 and 2007; ii) After tax, before minority interest; iii) Including direct and indirect presence, excluding representative offices; 1) Including announced acquisitions of ATF Bank in Kazakhstan and Ukrsotsbank in Ukraine on pro-forma basis; Turkey at 50% for each subsidiaries (YKB at 50%); incl. indirect presence in Azerbaijan, Kyrgyzstan and Tajikistan; 2) Excluding Bank Prestige due to data unavailability; 3) Excluding one-off effect due to the sale of Raiffeisenbank Ukraine and the stake in Bank TuranAlem; 4) Excluding Banca Popullore and Ohridska banka due to data unavailability; 5) BS and P&L data for Banca Italo-Albanese as of 2005; excluding American Bank of Albania due to data unavailability; 6) Data for Investsberbank and CJSC OTP Bank not included as not available

4 CENTRAL AND EASTERN EUROPE PULLED ALONG BY BANKS standards is one of the main drivers of economic growth throughout the region. Support for growth is also coming from the corporate sector with strong investment activity to enhance production capacity, especially in construction and infrastructural projects, also financed through FDIs creating the base for long term competitiveness. Moreover, all over the region, growth is coming with a fast contraction in risk. If we look at the rating actions undertaken by one of the major rating agency (S&P s) in the last three years, only in two cases a downgrade was awarded (Hungary and more recently Latvia), while more than 20 upgrades have been recorded. Moreover, most of the countries in the region are characterized by an investment grade rating (with Slovenia being on top of them with AA), and only Turkey, Ukraine and Serbia being a few notches below such a threshold. On top of a favourable economic convergence, the so called penetration gap versus the Eurozone has been per se a driver of growth. A first indication of such a gap is the ratio of the bankable population which has a current account, which is equal to 66% in the CEE region, versus almost 100% in West European countries like Austria. Another indicator is the ratio of banking assets over GDP. This ratio increased from 60% in 2004 to 70% in 2006, but it is still far from the one recorded in the Eurozone close to 300 per cent. But, of course, the regional average conceals significant differences between individual countries. Central Europe and the Baltics (CEB) indeed emerge as the most developed banking systems, followed by SEE countries and other countries. At single country level, Latvia, Estonia and Croatia are showing the highest financial penetration, while Romania and Russia the lowest. In the near future, despite a gradual fading of the financial penetration gap, banking volumes will continue to step up, particularly on the lending side. Such growth will be mostly driven by the catching up process in economic terms, enhancing the standard of living of the population, as well as by favourable cyclical features. We anticipate that loans volumes at the regional level will increase by 29% on average in the three years compared to around 23% growth expected on the deposits side. The strongest growth in banking volumes is still expected in fast converging countries such as Ukraine and Russia. To get an idea of the potential embedded in these markets, it is worthwhile to notice that over total new volumes to be generated in the region in the period, Russia and Ukraine will make around 60% of the total. Good opportunities to exploit are also expected in converging markets like Bulgaria and Romania and the Baltics. Credit expansion is expected to increasingly financed by alternative forms of funding, with foreign resources having a significant role. Following the strong upsurge in lending activity observed in the recent years especially in SEE and the Baltics, total banking deposits are already lower, in absolute levels than total loans, with the banking system relying on international capital markets or international debt for its funding. While on a microeconomic perspective, such funding gap is not a problem, if one considers that the banks are actually being financed by their mother companies, still concerns arise at the macroeconomic level, 38

5 EUROPE 2 revealing a huge potential for further growth. Important opportunities remain also on the corporate side, where good companies profitability and favourable macroeconomic developments are expected to support further decline in the cost of risk, with significant potential to exploit especially in the segment of factoring, leasing and investment banking products. mainly reflecting in widening international debt positions and/or current account deficit throughout the region. Retail remains the most dynamic segment The retail segment remains the most dynamic at the regional level, with households financial penetration increasing both on the assets and the liabilities side. Strong opportunities are expected especially on the lending side, with retail loans in Central and Eastern Europe expected to grow at annual average rate of about 35% until Particular fast growth is anticipated in the case of Ukraine and Russia, where the sector will grow by 62% and 52% respectively, almost double the rate achieved by the CEE market as a whole. Russia is followed by Romania, Serbia and the Baltic States, where retail loans are expected to grow above or close to 30% in the next three years. While both consumer credit and housing loans have grown very fast in the recent past, the latter is still the product showing the strongest gap compared to more developed western markets (7% penetration over GDP in CEE vs 38% in the Eurozone at the end of last year) Corbis Strong growth in banking profitability The CEE region is expected to continue to deliver good results in terms of profitability, on the back of bright macroeconomic prospects and sustained growth in volumes. In 2006 alone, profits before taxes (and extraordinary items) in the CEE-9 countries 11 rose by 33% yoy to reach EUR 27.5bn, marking a significant acceleration compared to one year earlier (when it went up by 27 %). We anticipate that profits in the region will grow by 15.3% in the period, with all countries, except for Czech Republic (6%) and Hungary (7%), showing growth rates close or above 10% on yearly basis. Still, the strongest increase is expected in the case of Russia with an average growth of 19.7% in pretax profits in the period. Good profitability results are also expected in the case of Bulgaria (14.3%) and Poland (13.7 per cent). 1. CEE: BG, BiH, HR, CZ, EE, HU, LV, LT, PL, RO, RU, SK, SI, SRB, TK and UA 2. Including privatization of the largest Romanian bank, BCR 3. Including ATF Bank (Kazakhstan) and Ukrsotsbank (Ukraine) on pro-forma basis; Turkey at 50% for each subsidiaries (YKB at 50%) 4. Including Bank Prestige (Ukraine) on pro-forma basis Net from one-off effect due to the sale of Raiffeisenbank