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Is there a credit crisis in CEE?

We launched a new wing of the Financial Services Club for Central & Eastern Europe on Wednesday.

The first meeting was a discussion based around the theme: "Is there are crisis in CEE?" with four esteemed panellists, namely:

  • Dr.Friedhelm Boshcert, CEO, Volksbank International  (furthest left);
  • Josip Protega, President of the Management Board, Hrvatska postbanska banka (second from left);
  • Dr. Karl Sevelda, Board Member, RZB Group (furthest right); and
  • Dr. Daniel (Danny) Thorniley, Senior Vice President, the Economist Group (second from right).

Picture14

The chaps in the middle are Simon Smith, the British Ambassador to the Republic of Austria, and myself.

I kicked off the panel discussions by giving a backdrop of my own reading of the financial crisis in CEE.

In
particular, I cited two articles about the CEE region and the crisis
both from October 2008. The first was from the New York Times, who had
a headline: “Bank Crisis is Bypassing Central and Eastern Europe”. The second, from the same time, came from Business Week with the headline: “Economic Problems Threaten Central and Eastern Europe”.

Which one was right?

As
it turns out the latter, with Hungary and Ukraine suffering particular
strains requiring the International Monetary Fund (IMF) to provide
billions of dollars of support shortly thereafter, as well as the
Baltics (Estonia, Latvia, Lithuania), Romania and Bulgaria all now
seeing issues due to foreign exchange rates.

For example, the CEE
region has built-up over $1.6 trillion of foreign debt according to
Morgan Stanley. Of this, $1.5 trillion came from Eurozone, Swiss and
Swedish banks with Austria exposed to $297 billion of debt, Germany
$214 billion and Italy $212 billion. Meanwhile, Sweden accounts for $83
billion of the $123 billion due from the Baltic states.

These are
likely to default as the region finds that the euro has strengthened
considerable against domestic currencies during the last few months,
and hence these debts are inflated by 20% or more.

As a result, there are strains between foreign banks and domestic needs which will need to be resolved.

On that cheerful note, I handed over to Danny Thorniley to expand on how these issues relate to the area.

Mr. Thorniley pointed to the fact that there are issues globally, with German Bonds not
selling as they should; China’s growth declining to levels that may
create worldwide instabilities; growth in other economies stuttering,
such as Poland; and worse.

In particular, in a joking way, he related the fact that lipstick and beer sales are rising, which only
ever happens in a recession. The reason is that ladies want to look
more attractive for their partners … but their partners are often too
sozzled to notice.

But Mr. Thorniley had some serious points about the lack of
lending of new capital is because there was no agreement between banks
and government agencies as to how that new capital should
be used. As a result, banks used it to shore up their Tier 1
Capital and restructure their balance sheets.

If governments
really want to make a difference, they have to agree with the banks the
use of funds, and then overcome bank fears around counterparty risks by
stating that they will guarantee any counterparty risk.

It is
his belief that the combination of these approaches – agreeing how to
use funds with state guarantees – will start to move money into the
lending cycle again.

He
finished by stating that emerging markets should still be seen as the
future for growth, including CEE; and that, whatever else happens,
don’t forget the customer as the customer is the one that will get you
through all of this long-term.

Dr. Karl Sevelda of RZB concurred wholeheartedly with this last point, and had a few key points of his own to raise too.

First,
governments within CEE are deluding themselves if they believe
that banks will get them out of this crisis. The issue here is that banks in many
CEE countries are foreign owned, and those banks now have domestic issues to contend with.  Those domestic issues will take priority, leaving overseas support down on the list.
Therefore, the foreign subsidiaries of banks in CEE countries are the
least likely to address CEE's issues. Instead, the governments must
address the issues.

Unfortunately, some of these authorities today believe
they can ignore domestic economic issues, as overseas funding from foreign
banks will ripple through into their economies to save financial
collapse.

They probably will not, was Dr. Sevelda's contention.

Second, the issue is not liquidity in CEE but
provisioning against bad loans and foreign exchange deficits. Dr.
Sevelda felt that liquidity would improve as government measures begin
to take effect through 2009, but that the region’s reliance on foreign
debt is the core exposure and issue that must be addressed.

He
mentioned a few other concerns.  One point of particular note is that banks must
not be run by risk managers, as a risk manager’s idea of the
safest form of lending is to ensure that loans are not given.

Dr. Sevelda recommended that CEE’s
banks will not be saved by the foreign banks, as foreign banks are
focusing upon their own liquidity first. Therefore, we must co-operate
across the region between domestic and local banks, local governments
and the IMF for provisioning of funds to cover FX and loan defaults.

In addition, regardless of the internal market issues, banks must
not forget the focus upon the customer.  We,
as banks, must continue to service the customer first and foremost and not
withdraw support, as this would be a fundamental breach of trust and
must not be allowed to happen. Otherwise, there will be no hope for the
banks after the crisis has passed.

On
that note, we moved on to Josip Protega who
lightened the tone slightly, in an unusual way, by complementing the
heating at the British Embassy. Coming from Croatia, he quipped, you
may think a financial crisis is a serious issue but a gas crisis during the winter months is an even bigger one.

Of course, he was referring to the fact that there is no gas getting
to Croatia from Russia right now, due to the strains in the Ukraine.
The idea of living in Zagreb in the cold during a snow storm may be an
amusing, if not worrying way, of showing just how connected the region
is!

Mr. Protega then expanded upon the theme and made it clear
that the budget deficits that exist in most countries mean that there
is no ability to refinance right now. As a result, businesses have no
working capital and firms are being forced to close down.

Nevertheless, countries like Croatia will survive 2009, with the
operative word being ‘survive’, as they have enough local funding to
cover all of their debt and financing needs this year. Then, in 2010,
he hopes that CEE will move away to reliance on local funding as the
region will be able to recover thanks to the EU and American actions in
the core system to start taking effect and liquidity returns to the
region.

His forecast therefore is that there will still be
growth in most CEE counties. Growth may slip to 1%, 2% or 3%, rather
than the levels of the past few years, but there will still be growth,
still be exports and still be trade. He just hopes that (a) 2010 sees a
return to some form of foreign bank and debt servicing and (b) that
other CEE countries have enough local funding to survive 2009.

The implication of the last point is that some countries may not. Another Iceland on the way?

Anyways,
last but not least, I introduced Dr Friedholm Boschert to the dialogue,
and he quite rightly delineated between the CEE countries that had the
most exposure versus those who had more robustness.

In fact he
opened with the view that there is no CEE region, just a range of
diverse countries that came under the banner CEE. These countries were
separated by trade, debt, savings and culture, and could be placed into
a range of camps, such as those with a trade surplus versus those with
a trade deficit.

Trade surplus countries, such as the Czech
Republic and Poland, would be affected by exports and the economies of
the rest of the EU and USA, but would survive this crisis thanks to
their ability to service their debts. Trade deficit countries that may
also have issues with low savings – such as Serbia, Romania and the
Ukraine – will be far more exposed to currency risks and exchange rate
movements.

Even so, he had some confidence in the ability of all
CEE countries to survive. This confidence is based upon the fact that
the debt burden of most countries against GDP when compared with the
EU14, the traditional and founding countries of the EU, was low.
Therefore, the issues in CEE do exist but nowhere near as leveraged or
as high as the debt issues that the EU14 are suffering.

As a result, CEE governments will this year need to focus upon
servicing domestic business with domestic funds, as all FX loans have
disappeared and will not return for some time to come.

Dr.
Boschert concluded that he felt the two major issues for CEE banks were
slightly different to those raised by Dr. Throniley, Dr. Sevelda and
Herr. Proega however. He felt the issues were (a) that banks were in
danger of destroying trust and so how would we ever regain such trust
again; and (b) what happens to the unbanked during the next few years,
with a very large population of unbanked in CEE countries.

All
in all, the discussion, meeting, dialogue and questions were
stimulating, through-provoking and opened me up to a whole new range of
ideas and understanding about the challenges of old economies and new
ones, along with European integration, that I had not considered before.

I
concluded therefore by saying that we had strains in the EU14, as Dr.
Boschert referred to the old and founding EU constituents.

Spain
has just been demoted by S&P creating even more uncertainty in
their economy, on top of the unemployment and property issues that are
at breaking point already, as is Portugal. Italy has always had a large
anti-euro constituency, and Greece has riots over the constraints of
being part of the Eurozone.

Therefore, there is a possibility
that we could see, thanks to this crisis, even more European tension as
countries constrained by the Eurozone requirements struggle to get
through 2009.

That is why I liked Josip Protega’s phrase, “Survive 2009”, as survival is very much going to be the theme for many this year.

What
this means for CEE countries is that they may actually become even
stronger as a constituency as a result. After all, if they cannot help
each other survive 2009, no-one will. They cannot look for support from
the EU14, for the reasons given, and so a co-operative constituency of
the new countries must be the way to go should the crisis force it that way.

Help each other, work together, collaborate together and resolve the issues as best we can.

About Chris M Skinner

Chris M Skinner
Chris Skinner is best known as an independent commentator on the financial markets through his blog, the Finanser.com, as author of the bestselling book Digital Bank, and Chair of the European networking forum the Financial Services Club. He has been voted one of the most influential people in banking by The Financial Brand (as well as one of the best blogs), a FinTech Titan (Next Bank), one of the Fintech Leaders you need to follow (City AM, Deluxe and Jax Finance), as well as one of the Top 40 most influential people in financial technology by the Wall Street Journal’s Financial News. To learn more click here...

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