Macro Focus Group Economics Emerging Markets Arjen van DijkhuizenEuropean banks reduce funding to Eastern Europe Tel: +31 20 628 8052 13 July 2012 • Strong bank funding links between emerging Europe and (South) Western Europe. Strong linkages connect emerging Europe’s economic fortunes with that of (South) Western Europe, as was shown during the global crisis in 2008/09. Although the region has recovered from this crisis, it remains dependent on (South) Western Europe and vulnerable to contagion from the eurocrisis. In this report we zoom in at this vulnerability from an external bank funding perspective, although trade and investment are other key contagion channels. • Fresh wave of deleveraging by (South) Western European banks. Regional external imbalances have declined since the global financial crisis, reducing dependence on external finance. Total European bank exposure to the region fell by USD 365 bn (-23%) between mid-2008 and mid-2010, followed by a recovery of USD 249 bn between mid-2011 and mid-2011. A fresh deleveraging wave (USD 188 bn or -13%) took place in the second half of 2011, when the eurocrisis escalated and global risk aversion surged. • No complete funding stop. Emerging Europe has not faced a complete funding stop during the escalation of the eurocrisis so far – as some had feared. Some countries like Hungary, Cyprus and Slovenia are faced with a relatively large decline of external funding; this also reflects country-specific risks. The ECB’s LTROs, in particular, and the second Vienna Initiative have contributed to preventing a sudden funding stop. But these initiatives will not be sufficient to prevent a longer term deleveraging trend. • External (parent) bank funding remains key. External (parent) bank funding continues to play an important role in emerging Europe, given the high degree of foreign bank ownership and high loan-to-deposit rates in many countries. Compared to economic size, dependence on European bank funding is very high in Cyprus and Croatia, followed by the Czech Republic. Austrian and Italian banks have the highest exposures. Greek banks are heavily involved in Cyprus, but also important in Bulgaria, Serbia and Romania. • High dependence on European bank funding leaves the region extra vulnerable to eurocrisis. The impact of deleveraging by European banks on emerging European economies through the credit channel may of course be compensated by local or other foreign banks stepping in, although on balance bank assets to GDP ratios have generally declined over the past years. Moreover, other forms of external financing (like FDI or portfolio inflows) play a role as well in shaping regional funding conditions. In any case, the still high dependence on European bank funding (besides other trade and financial linkages) leaves the region vulnerable to a further escalation of the eurocrisis, such as a financing crisis in Spain and/or Italy, a disorderly Greek exit from the eurozone or an even broader break-up of the currency union. Longer-term, the region’s stability of the region would in fact profit from a reduced dependence on external (European) bank funding and a further decline of loan-to-deposit ratios.
2 Macro Focus - European banks reduce funding to Eastern Europe - 13 JulyIntroduction emerging European countries have declined since the globalStrong trade and financial linkages connect emerging Europe’s crisis, meaning that their dependence on external finance iseconomic fortunes with that of (South) Western Europe. This now lower than before the global financial crisis.was clearly shown during the crisis of 2008/09, when a globalrecession caused regional exports – mainly destined for the … but still high in some countrieseurozone – to collapse. Simultaneously, a surge in global risk Despite the general reduction of imbalances, the externalaversion led to the drying up of capital inflows from the West. position of several countries is still fragile. Serbia, Turkey,These events caused severe fiscal, banking and balance of Belarus and Romania have large current account deficitspayment pressures across the region. Complementary to ranging between 6% and 10% of GDP. External debt isIMF/EU rescue programmes, through the so-called Vienna particularly high (> 100% GDP) in Hungary, Latvia, Estonia,Initiative foreign banks active in the region agreed to roll-over Slovenia and Croatia. By contrast, the external position of theexposures and inject capital were needed to prevent a region’s largest economy, Russia, is strong. Russia’s currentsystemic crisis in the region. Although emerging Europe has account shows structural surpluses, external debt is low andrecovered from the 2008/09 global crisis, the region remains FX reserves are very high. Its strong external position is andependent on (South) Western Europe and vulnerable to important pillar of Russia’s investment grade ratings.contagion from the eurocrisis. In this report, we will zoom in atthis vulnerability from an external bank funding perspective. External indicators % GDPExternal imbalances generally reduced …Before the global financial crisis in 2008/09, emerging 5 RUS Current account balanceEurope’s growth model was based on external capital inflows EST HUNfeeding a domestic credit boom. This model went hand-in- BUL SLO 0hand with the built-up of various imbalances such as high SLR LIT CZE CRO LATcurrent account deficits. Particularly in countries with fixed POL UKRexchange rates (Bulgaria, Baltics) but also in Romania and -5 ROMSerbia, current account deficits surged to 15-25% of GDP in BEL2007. After the collapse of Lehman Brothers in the autumn of TUR -10 SER2008, a surge in global risk aversion caused capital flows toemerging Europe to dry up, marking the end of the region’s 0 25 50 75 100 125 150growth model. External debt Source: ABN AMRO Group Economics, EIUExternal correction between 2007 and 2012 Change in current account balance, % points GDP Importance of external (parent) bank funding 25 As a source of external funding, (parent) bank funding is traditionally important for emerging Europe. In particular 20 Austrian and Italian banks are very active in Central Europe 15 and the Balkans, while Swedish banks dominate the Baltic 10 banking landscape. In many countries, foreign bank ownership corresponds to 60% of bank assets or more. In the Czech 5 Republic, for instance, almost 80% of bank assets belongs to 0 foreign-owned banks (predominantly of Austrian and Belgian origin). In Poland and Hungary, this share is 60%. Croatia has -5 the largest share of foreign-ownership (90%), mainly of Italian N R E L P M R R R S O L T L O T T L BU CZ or Austrian origin. ES SE CY BE PO A LA TU LI SL U K RU CR SL RO H U MSource: ABN AMRO Group Economics, EIU A second factor explaining the importance of external bank funding stems from the high loan-to-deposit ratios in manyThe crisis has triggered a strong external adjustment in a large countries. These are particularly high for Ukraine (155% inmajority of countries, visible for instance in the significant 2011) and Hungary (143%), but also for Serbia, Romania andimprovement of current account balances since 2007. This is Croatia (around 120%). Looking at another vulnerabilityparticularly true for Bulgaria and the Baltics, where the current indicator, foreign liabilities to total funds, Hungary, Serbia,account balance improved by 15-20% points of GDP since Romania and Croatia again score high together with Bulgaria.2007. But also Hungary, Serbia, Romania and Croatia show a The Czech Republic ranks well on both indicators, confirmingcurrent account correction of more than 5% points of GDP that the Czech banking sector is one of the region’s healthiest.since 2007. To conclude, external imbalances of most
3 Macro Focus - European banks reduce funding to Eastern Europe - 13 JulyEmerging European banks: some indicators European banking exposure to Emerging Europe % USD bn. 160 1600 120 1200 800 80 400 40 0 0 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11 UKR HUN SER ROM CRO POL RUS TUR BUL SLR CZE GIIPS Austria France Germany Loan to deposit ratio Foreign liabilities to total funds Netherlands UK OtherSource: Global Insight Source: BIS, ABN AMRO Group EconomicsForeign ownership of banks in Russia and Turkey is far below Peripheral banking exposure to Emerging Europethe regional average, so we will treat them as a different USD bn.category as the issue of external bank deleveraging is lessimportant for them. We will also set Ukraine apart, as the 400exposure of Russian banks (which are quite active in Ukraine)is not included in the BIS data which we will use. 300 200Banks’ funding patterns since the global financial crisisGiven the importance of (parent) bank funding for emerging 100Europe, a multilateral initiative was launched in 2009 toprevent a systemic crisis in the region. In the so-called Vienna 0Initiative, foreign banks active in the region (mainly Austrian)agreed to roll-over exposures and inject capital where needed, Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11while multilateral institutions (IMF, World Bank, EBRD) Italy Greece Spain Portugal Irelandcommitted to new lending arrangements. We will look at Source: BIS, ABN AMRO Group EconomicsEuropean bank funding to emerging Europe using BIS data.Although these data lag by around half a year (latest available Rebalancing between mid-2008 and mid-2011data refer to end-2011), we will use them to have a closer look The Vienna Initiative has contributed to restoring regionalat funding patterns and possible risks stemming from these.1 financial stability, as it has prevented a ‘rush to the exit’ by Western banks from emerging Europe. Such an exit wouldLarge share regional bank funding from Austria and Italy have significantly disrupted the credit mechanism in emergingAlmost half of European bank funding to emerging Europe European countries, which would have damaged thesecomes from Austria (average share 21% in the period 2005- economies – already in distress during the global crisis – even2011) and the five eurozone ‘peripheral’ countries Greece, more. But despite the initiative, European bank funding toIreland, Italy, Portugal and Spain (average share 23%). In late emerging Europe – which covers more than 95% of global2011, the respective shares of Austria and the periphery were bank exposure – has declined in the immediate aftermath of20% and 28%. Within the periphery, Italy clearly stands out the global financial crisis. Between mid-2008 and mid-2010,with a share in total European bank funding of 16% in late total European bank exposure to emerging Europe declined by2011. French banks had a share of 11.5% in late 2011, USD 365 bn (23%). It was not before mid-2010 that Europeanfollowed by German banks (10.5%), Greek banks (7%), Dutch banking exposure to the region started rising again. But thisbanks (6.5%), UK banks (5%) and Spanish banks (3%). correction did not last long, until mid-2011. Between mid-2010 and mid-2011 European bank funding to emerging Europe rose by USD 249 bn. On balance, between mid-2008 and mid-1 The BIS data used here capture all foreign claims of the reporting banking 2011, total European bank funding to emerging Europe wassystems on an ultimate risk basis. According to the BIS website, these data reduced by USD 116 bn (-7%). But we see strong differencescover all contractual lending by the head office and all its branches andsubsidiaries on a worldwide consolidated basis (so net of inter-office among the countries concerned. German banks have reducedaccounts). We have taken the ‘ultimate-risk basis’ data, reflecting that their emerging European exposure by USD 86 bn in thisbanks’ country risk exposures can differ from that of contractual lending dueto the use of risk mitigants such as collateral. period, followed by Irish and Dutch banks (next chart, green
4 Macro Focus - European banks reduce funding to Eastern Europe - 13 Julybars). According to the BIS data, Spanish banks (+ USD 42 eurocrisis in terms of banking sector and fiscal issues. Polandbn) and Greek banks (together with UK banks) have in fact and the Czech Republic were also faced by a relative strongincreased their emerging European exposure in this episode. decline of European bank funding in the second half of 2011.Change in banking exposure to Emerging Europe Change in external bank funding from Western Europe USD bn. % 50 30 25 20 10 0 0 -25 -10 -50 -20 -30 -75 -40 -100 R N S R R L ZE K M T O L YP T V T K U U U TU ES SE PO SL LA R LI O SL U R H B C C DE IE NL IT AT PT FR UK GR GIIPS ES C R June 2011 vs June 2008 Dec 2011 vs June 2011 June 2011 vs June 2008 December 2011 vs June 2011Source: BIS, ABN AMRO Group Economics Source: BIS, ABN AMRO Group EconomicsFresh wave of deleveraging since mid-2011 … But Western European bank funding still very importantThe yellow bars in the previous chart show the changes in Despite the deleveraging trend, bank funding from (South)exposures between June 2011 and December 2011. This Western European banks continues to be very relevant forepisode covers the further escalation of the eurocrisis. This emerging European economies. We can show this by lookingwas marked by a further deleveraging by Western banks vis-à- at the size of external bank funding in relation to the size of thevis emerging Europe. Total European bank exposures to the economy. The next chart shows per recipient country the ratioregion were reduced across the board in this period, by a total of total funding by European banks to GDP, thereby explicitlyof USD 188 bn, or 13% of the outstanding exposure. In distinguishing between Austrian, Italian, French, German,absolute terms, Austrian banks reduced their exposures to the Greek and other European bank exposure. European bankregion the most in this period, followed by German, French funding corresponds to 50% or more of GDP in most countries,and Italian banks. In relative terms, Irish banks reduced their with the exception of Poland (and Turkey, Ukraine and Russiaexposures to the region the most, followed by Portuguese, as mentioned before). For the Czech Republic (and Estonia),German, Austrian and Spanish banks. The underlying data this share is around 80% of GDP. In the Czech Republic,show that the heavily exposed Austrian banks were alreading Austrian banks are very active. Hungary (where Austrian andreducing their exposure to emerging Europe before the Italian banks are quite active) ranks in the middle of the pack.Austrian supervisors tightened lending rules in November2011. Moreover, they lend support to the assumption that Dependence on European bank fundingbanks from the eurozone periphery got particularly strained – % GDPat least since mid-2011 – and therefore have a relatively high 140tendency to delever externally compared to the average. 120… also from a recipient country’s perspective 100From a recipient country’s perspective, between June 2008 80and June 2011 almost all countries (except Turkey, Poland 60and the Czech Republic) witnessed a decline in external bank 40funding from Western Europe (next chart, green bars). To the 20countries faced with the highest degree of external 0deleveraging belong crisis-struck Cyprus and Hungary and the N R S R R L ZE O K M T L YP T V T U U K U TU ES SE PO SL LA R LI SL O C H B U R C C RBaltics which experienced an extreme external correction. In Austrian banks Italian banks French banksthe more recent period (yellow bars), all emerging European German banks Greek banks Other European bankscountries face a decline in European bank funding. Hungary is Source: BIS, ABN AMRO Group Economicshit the most in the second half of 2011, reflecting a range ofpolitical and economic risks resulting in the loss of the Cyprus – a regional banking sector with high external (bank)country’s investment grade rating. Hungary is followed by debt – is by far the most dependent on Western bank fundingSlovenia, which also was struck with contagion from the in GDP terms. Total European bank funding to Cyprus
5 Macro Focus - European banks reduce funding to Eastern Europe - 13 Julycorresponded to 135% of GDP in late 2011, with the largest balance sheet problems forcing them to reduce foreignshares of external funding (around one third) coming from exposures. Finally, across Europe, banks will be faced byGreece. Vice versa, Cypriot banks also have large exposures political pressure to create room in their balance sheets toto Greece. The strong interconnectedness between Cyprus increase credit growth at home markets, which may come toand Greece was the main reason why Cyprus had to request the detriment of foreign funding.an EU/IMF bailout in June. Croatia – which also has a fragileexternal position as discussed above – comes in second with Conclusionstotal European bank funding equivalent to 110% of GDP. The Emerging Europe’s external imbalances have declined sincechart also shows that Greek bank funding is particularly the 2008/09 crisis, reducing the region’s dependence onrelevant for Bulgaria, Serbia and Romania (next to Cyprus) external finance. This mirrors the development of Europeanand confirms that the Baltics are very dependent on ‘other banks’ funding patterns to the region. Total European bankEuropean bank funding’ i.e. funding from Swedish banks. exposure to emerging Europe fell by USD 365 bn (-23%) between mid-2008 and mid-2010, which was followed by aWill LTROs and Vienna 2.0 save the day? recovery of USD 249 bn between mid 2011 and mid 2011. AAs the BIS data used refer to end-2011, the question rises fresh wave of deleveraging (USD 188 bn or -13%) took placewhat has happened since. Will the picture change if we take in the second half of 2011, when the eurocrisis escalated andinto account 1) the introduction of special liquidity operations global risk aversion surged.with a three-year maturity (LTROs) by the ECB in December2011 and February 2012 for a cumulative EUR 1 trillion and 2) Emerging Europe has not faced a complete funding stopa second Vienna Initiative launched last January? during the escalation of the eurocrisis so far – as some had feared. Some countries like Hungary, Cyprus and Slovenia areIn our opinion, the LTROs in particular have been important in faced with a relatively large decline of external funding; thispreventing a sudden halt of capital flows towards emerging also reflects country-specific risks. The ECB’s LTROs, inEurope as they have provided breathing space to banks particular, and the second Vienna Initiative have contributed toacross Europe and have helped to improve the conditions on preventing a sudden funding stop. But these initiatives will notthe European interbank markets. The LTROs have also be sufficient to prevent a longer term deleveraging trendcreated room for peripheral banks to increase purchases ofdomestic government bond holdings, thereby alleviate funding External bank funding still plays a key role in emergingpressures for peripheral sovereigns. Without these Europe, given the high degree of foreign ownership in regionalinstruments, banking distress across Europe would probably banking sectors and the still high loan-to-deposit rate in manyhave been more extreme and external deleveraging towards countries. Austrian and Italian banks still have the highestemerging Europe probably more significant. With regard to the exposures in the region. Compared to economic size, the rolesecond Vienna Initiative, this will have contributed to of European bank funding is still very high in Cyprus andpreventing such a ‘sudden stop’, although we doubt whether Croatia, but also in the Czech Republic (whose banking sectorthe sequel has been as successful as the original. continues to be one of the region’s healthiest) and the Baltics. Greek banks were heavily involved in Cyprus in late 2011, butWhile both initiatives have been useful in preventing sudden also quite important in Bulgaria, Serbia and Romania.funding stops so far, they will probably not be sufficient toprevent a longer-term deleveraging trend towards emerging The impact of deleveraging by European banks on emergingEurope (and other emerging regions). This trend is a function European economies through the credit channel may of courseof demand and supply factors. With regional growth staying be compensated by local or other foreign banks stepping in,below pre-crisis levels, loan demand has slowed. Moreover, as although on balance bank assets to GDP ratios have generallydiscussed above, external imbalances have generally declined declined over the past years. Moreover, other forms of externalsince the global crisis, meaning that there is less need for financing (like FDI or portfolio inflows) play a role in shapingexternal financing. On the supply side, Western European regional funding conditions as well. In any case, the still highbanks are faced with the tightening of (inter)national dependence on European bank funding (besides other tradesupervision standards forcing them to delever externally. and financial linkages) leaves the region vulnerable to a furtherFaced with a legacy of high exposures in emerging Europe, escalation of the eurocrisis, such as a financing crisis in SpainAustrian banks, for instance, were ordered by their supervisors and/or Italy, a disorderly Greek exit from the eurozone or anin November 2011 to limit regional lending growth to what they even broader break-up of the currency union. Longer-term, thecould raise locally. The further tightening of bank capital region’s stability of the region would in fact profit from astandards by EBA has also impacted on the need for banks to reduced dependence on external (European) bank funding anddelever.2 Peripheral banks, in particular, are faced with a further decline of loan-to-deposit ratios.2 In October 2011, EBA required banks to mark-to-market sovereign bond an estimated additional EUR 115 bn capital need for European banksholdings and raise capital ratios to 9% in June 2012. These revisions lead to (World Bank, Global Economic Prospects, June 2012).