Bloomberg News

European Lenders in Talks to Stem East Europe Crisis Damage

November 16, 2011

(Updates with economist comment in 16th paragraph.)

Nov. 15 (Bloomberg) -- The European Bank for Reconstruction and Development, lenders and officials from across the continent are in talks for a second time in three years to prevent funds for eastern banking units from drying up.

The solution will differ from the Vienna Initiative, a 2008 pledge from Europe’s biggest banks to back their subsidiaries in nations such as Poland and Hungary after Lehman Brothers Holdings Inc.’s collapse, Piroska Nagy, director of country strategy and policy at the EBRD, said yesterday in an interview. An agreement may be reached in a few weeks, she added.

“What’s needed in the new situation is heightened coordination,” Nagy said in London. “Otherwise we’ll have negative spillovers from narrowly nation-based solutions.”

European leaders decided last month that the region’s banks must increase core capital reserves to 9 percent by mid-2012 as the sovereign-debt crisis threatens to spread to Italy and Spain. With about three-quarters of eastern Europe’s banking industry owned by lenders including UniCredit SpA and Erste Group Bank AG, local units are likely to receive less support as a result of the new requirements, the EBRD has warned.

Western European lenders need an extra 106 billion euros ($149 billion) of capital, according to the European Banking Authority. Italy’s UniCredit, the largest lender in eastern Europe, must raise 7.38 billion euros of fresh capital, it estimates. Erste, which owns the region’s second-biggest banking group, said Oct. 28 that it requires 750 million euros.

‘Another Crisis’

The euro region’s debt crisis may damp demand for eastern European exports and lower inflows of capital, similar to 2008, the EBRD said today in its annual Transition Report on the 29 former Soviet bloc countries where it invests.

“Unfortunately the region again has reasons to prepare itself for another crisis,” chief economist Erik Berglof said in the report. “If the crisis spins out of control, the financial integration model across advanced and emerging Europe and beyond may be in jeopardy.”

Economies in the region have strengthened since 2008 and are less dependent on external financing, while bank balance sheets are generally sturdier the EBRD said. Still, lenders may need more capital because of high levels of non-performing loans, which probably haven’t peaked yet, the EBRD said.

The turmoil in advanced European nations poses “significant risks even to the already worsened outlook,” the EBRD said. Hungary, Slovakia, Bulgaria are most vulnerable to contagion, followed by Croatia, Slovenia, Romania and Poland, according to the EBRD.

Currencies Plunge

The Hungarian forint and the Czech koruna are the world’s two worst performers in the past month, declining 8.8 percent and 5.9 percent, according to Bloomberg data. The Serbian dinar is the third-weakest, sliding 4.8 percent, while Poland’s zloty is fourth, dropping 4.5 percent.

Moody’s Investors Service today cut the outlook for Poland’s banking industry to negative from stable, citing a deteriorating “operating environment.”

“Weaker growth in the major Western European countries, Poland’s principal trading partners, fiscal consolidation and restrained bank lending will suppress the pace of economic expansion in Poland and affect banking system performance,” Moody’s said in a statement.

Moody’s “expects pressures to build gradually over the next 12-18 months, adversely affecting asset quality, liquidity and profitability.”

Credit Squeeze

Eastern Europe may face a credit squeeze as neighboring western banks withdraw liquidity, Christine Lagarde, managing director of the International Monetary Fund, warned Nov. 7.

The region’s financial stability is at risk as western European lenders trim their balance sheets by as much as 2.5 trillion euros to meet capital requirements, Morgan Stanley said yesterday.

“Banks are forced to make some acutely difficult decisions” and may place the priority on “their short-term survival” over decisions “made with long term strategic interests in mind,” Royal Bank of Scotland Group Plc emerging- market economists Tim Ash and David Petitcolin said today in an e-mailed report.

‘Worrying Effect’

Western European banks may unwind about 13 billion euros of assets in eastern Europe, Peter Attard Montalto, a London-based economist at Nomura International Plc, said Nov. 4 in an e- mailed note.

There may be “a worrying effect on southeastern Europe, particularly Bulgaria, Serbia and Romania, as well as Hungary, given both the sizes of assets involved and the more stressed market dynamic,” he wrote. “We see a potential Vienna 2 and domestic measures like capital controls, use of reserves and potential nationalization as adding to the backstop against a disorderly impact on emerging Europe.”

European leaders and the EBA are aware of the threat to eastern bank units, with lenders and the authorities working together more closely than in 2008-09 to address the risks, according to Nagy.

Financial supervisors should “take into account” banks’ subsidiaries when encouraging them to continue lending while raising capital reserves, the EBA said in a statement this year. Banks should avoid putting “undue pressure” on credit lines to companies in nations where they have units, the EBA said.

‘Beyond Liquidity Support’

“These principles really must be fully implemented so subsidiaries aren’t discriminated against,” Nagy said. “This means that beyond the recapitalization liquidity support is also provided in one way or another.”

There’s “no need and no desire” for western European lenders to remain committed to the Vienna initiative, Manfred Wimmer, Erste’s chief financial officer, said Oct. 29. The banks made the promise when countries such as Hungary and Romania had large current-account deficits and fewer options to finance themselves, he said.

“When they say there’s no need for a Vienna 2, people have in mind the specific outcome of the Vienna discussions at that time,” Nagy said, citing pledges to maintain financing to eastern European units and provide fresh capital as required.

This time round, it’s more about utilizing the framework those discussions created, according to Nagy.

“We have the reactivation of the Vienna platform,” she said.

--With assistance from Boris Groendahl in Vienna and Ben Moshinsky in London. Editors: Andrew Langley, Balazs Penz

To contact the reporters on this story: Agnes Lovasz in London at alovasz@bloomberg.net

To contact the editors responsible for this story: Balazs Penz at bpenz@bloomberg.net


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