POST- CRISIS BUSINESS MODEL OF BANKS IN THE REGION

Dr. György Surányi

Resident Regional Head

16-17, November, 2009

2

BEFORE THE CRISIS:

A MACROECONOMIC OVERVIEW

3

GDP GROWTH RATES WELL ABOVE THE EMU AVERAGE...

Before the crisis the consensus view was that in case of small, open, converging economies the sustainable growth strategies are export and investment-driven

growth strategies –actively supported by capital inflows(both debt- and non-debt type financing)

(C/A deficits!)Source: Eurostat, IMF

GDP GROWTH,CEE REGION

2,9

0,7

5,1

0,2

4,4 4,8

7,3

66,6

5,5

3

-5

-6

-4

-2

0

2

4

6

8

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

%

1991-2000 average: 2%2002-2008 average:5,4%

CAGR OF GDP1997-2007

2,7%

3,0%

3,1%

3,9%

4,0%

5,1%

6,4%

7,7%

7,4%

4,3%

4,1%

1,00% 3,00% 5,00% 7,00% 9,00%

RO

SRB

CZ

BG

CR

HU

PL

SK

LV

LT

EST

4

TOTAL INVESTMENTS (yearly growth rates%)

0

5

10

15

20

25

30

35

Bulgaria

Czech R

ep

Estonia

Latvia

Lithuania

Hungary

Poland

Rom

ania

Slovakia

1997-2001 average: 7,8%

2002-2006 average: 9,1%

2007 average:13,5%

EXPORTS (yearly growth rates%)

0

5

10

15

20

25

Bulgaria

Czech R

ep

Estonia

Latvia

Lithuania

Hungary

Poland

Rom

ania

Slovakia

1997-2001 average: 9,9%

2002-2006 average: 10,1%

2007 average:9%

EXPORT AND INVESTMENT DRIVEN GROWTH STRATEGIES

Source: Eurostat

5

STRONG GROWTH RATES PUSHED AHEAD REAL CONVERGENCE

Source: Eurostat

GDP/CAPITA (PPP, EU27 average=100)

81,3

71,6

68,6

64,5

60

58,1

54,6

53,2

40,4

38,1

72,9

42

51,3

53,1

38,6

34,6

46,8

52

26,3

26,4

0 20 40 60 80 100

Czech Republic

Estonia

Slovakia

Hungary

Lithuania

Latvia

Poland

Croatia

Romania

Bulgaria

2007

1997

6

In the CEE region almost all countries run external deficits or to put it another way: net domestic savings were negative

Before the current crisis it was considered sustainableA natural „side effect” of the catching up process

C/A DEFICIT A REGIONAL PHENOMENON

Source: IMF

CEE REGION, C/A DEFICIT AS A % OF GDP

-3,1

-4,4 -4,7

-2

-3

-4

-5,4-5

-6,6

-7,9 -8

-3,1-3,9

-9

-8

-7

-6

-5

-4

-3

-2

-1

0

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009*

2010*

7

DISCIPLINED FISCAL POLICIES

Source: IMF

BUDGET BALANCE (as a % of GDP)

-10

-8

-6

-4

-2

0

2

4

6

8

2001 2002 2003 2004 2005 2006 2007 2008

CEE

CIS

The external deficit was not the result of loose fiscal policies(SGP, Maastricht!)

8

GOVERNMENT DEBT (as a % of GDP)

69,5 70 68,3 66

25,526,830,3 28,1

0

10

20

30

40

50

60

70

80

2004 2005 2006 2007

EMU

average NMS+SK

60%

LOW DEBT LEVELS

Source: Eurostat

9

The first group: low inflation, healthy fiscal balances, acceptable external position, no asset price bubble

The second group: high inflation, huge external imbalances, asset price bubbles, consumption driven growth financed by cheap external funding

BUT DUE TO THE GLOBAL CRISIS ALL COUNTRIES FACE ALMOST SIMILAR CHALLENGES

PolandCzech Republic

SlovakiaRomaniaBulgaria

The Baltic statesUkraine

STABLE GROWTH, SUSTAINABLE INTERNAL AND EXTERNAL

BALANCES

SERIOUS IMBALANCES

Hungary

BUT THERE WERE DIFFERENCIES ACROSS THE REGION

Serbia

Croatia

10

In some countries domestic demand rose stronglyin spite of disciplined fiscal policies

HOUSEHOLDS' CONSUMPTION (%)

0

2

4

6

8

10

12

14

16

Bulgaria

Czech R

ep

Estonia

Latvia

Lithuania

Hungary

Poland

Rom

ania

Slovakia

1997-2001 average: 3,7%

2002-2006 average: 7,4%

2007 average: 7,8%

NUMBER OF UNEMPLOYED (%)

0

2

4

6

8

10

12

14

16

18

20

Bulgaria

Czech R

ep

Estonia

Latvia

Lithuania

Hungary

Poland

Rom

ania

Slovakia

1997-2001 average: 11,7%

2002-2006 average: 10,9%

2007 average: 6,8%

Source: Eurostat

BUT THERE WERE DIFFERENCIES ACROSS THE REGION

11

THE CRISIS: THE REGION ENTERED A DEEP RECESSION

12

THE CRISIS: THE REGION ENTERED A DEEP RECESSION

Source: IMF

GDP GROWTH RATES,CEE (%)

1,8

5,5

3

-5-6

-4

-2

0

2

4

6

8

1991-2000 2007 2008 2009

2009 versus 2007:~-10,5% change in the

grow th rate

GDP GROWTH RATES (%) CEE AND CIS

-5

-6,7-8

-6

-4

-2

0

2

4

6

8

10

2001 2002 2003 2004 2005 2006 2007 2008 2009*

CEE

CIS

2002-2006 averageCEE: 5.8%CIS: 7.3%

13

EXPORT MARKETS COLLAPSED

Exports are down ~25-35% y-o-y

EXPORT VALUE (change, %)

-25

-36,7

-50

-40

-30

-20

-10

0

10

20

30

40

50

2001 2002 2003 2004 2005 2006 2007 2008 2009*

CEE

CIS

IMPORT VALUE (change, %)

-31,6

-33,4

-40

-30

-20

-10

0

10

20

30

40

2001 2002 2003 2004 2005 2006 2007 2008 2009*

CEE

CIS

2002-2006 averageCEE: 22.5%CIS: 24.1%

2002-2006 averageCEE: 23.8%CIS: 25.7%

Source: IMF

14

SUDDEN STOP OF CAPITAL INFLOWS

Source: IMF, IMF sraff estimates

NET CAPITAL INFLOWS TO THE CEE REGION1990-2014* (as a % of GDP)

-6

-4

-2

0

2

4

6

8

10

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

15

EMU 2008-2010: -2.5%

Source: Eurostat, Brussel Commission

Sustainability fears (even in case of low debt countries), the appearance of roll- over risks!

Fiscal policies are not in a position to give a countercyclical boost to the economy

FISCAL POLICIES ARE NOT ABLE TO PROVIDE A SHELTER

CHANGE IN THE CYCLICALLY ADJUSTED BUDGET BALANCE (% of GDP)

-8

-6

-4

-2

0

2

4

6

8

10

SK RO PL HU LIT LV EST CZ BG

CHANGE 2006-2010 (average: -1,1%)

CHANGE 2008-2010 (average: +0,1%)

CHANGE 2007-2009 (average:-1,3%)

CHANGE IN THE CYCLICALLY ADJUSTED BUDGET BALANCE (% of GDP)

-16

-14

-12

-10

-8

-6

-4

-2

0

FR ESP IRE GER

CHANGE 2006-2010(average: -7.3%)

CHANGE 2008-2010(average: -3.3%)

CHANGE 2007-2009(average: -5.8%)

16

RISING UNEMPLOYMENT, FALLING CONSUMPTION

Source: Eurostat, Brussel Commission

HOUSEHOLDS' CONSUMPTION (%)

-30

-20

-10

0

10

20

30

Bulgaria

Czech R

ep

Estonia

Latvia

Lithuania

Hungary

Poland

Rom

ania

Slovakia

2007 average: 7,8% 2008 average:1,3% 2009* average:-9,1%

NUMBER OF UNEMPLOYED (%)

0

2

4

6

8

10

12

14

16

18

Bulgaria

Czech R

ep

Estonia

Latvia

Lithuania

Hungary

Poland

Rom

ania

Slovakia

2007 average: 6,8%

2008 average:6,6%

2009* average:11%

17

CHANGE IN REAL PER CAPITA GDP (%)

-8

-6

-4

-2

0

2

4

6

8

10

2001 2002 2003 2004 2005 2006 2007 2008 2009*

CEE

CIS

Source: IMF

REAL CONVERGENCE CAME TO A HALT

18

THE BANKING SECTOR

19

AVERAGE REAL CREDIT GROWTH OVER THE LAST 5 YEARS (%)

13,1 14,3 14,7 16

26,2 27,329,8

34,5 35,938,4

43,247,1 47,5

50,1

0

10

20

30

40

50

60

Croatia

Hungary

Poland

Czech R

epublic

Serbia

Estonia

Turkey

Russia

Bulgaria

Latvia

Lithuania

Rom

ania

Ukraine

Kazakhstan

BEFORE THE CRISIS: STRONG CREDIT GROWTH ACROSS THE REGION

Source: IMF,2004-2008

20

Source:IMF

STILL RELATIVELY LOW LEVEL OF FINANCIAL INTERMEDIATION

PRIVATE SECTOR CREDIT TO GDP IN SELECTED COUNTRIES (eop,%)

0%

20%

40%

60%

80%

100%

120%

140%

160%

Bulgaria Croatia Czech Rep Estonia Hungary Latvia Lithuania Poland Romania Slovakia euro zone

2000 2001 2002 2003 2004 2005 2006 2007 2008

21

THE CREDIT GROWTH WAS FINANCED BY CHEAP EXTERNAL FUNDING

Source: NBH

Foreign banks play a leading role in the region

Foreign-controlled equity/total equity: ~70-90%

RATIO OF FOREIGN BORROWING TO TOTAL FUNDS IN THE CEE BANKING SECTORS

( as of December 2008, values indicates the value of total foreign loans in bln EUR)

12

3

26

42

30

16

9

40

0

10

20

30

40

50

60

70

Bal

ticst

ates BG CZ

HU PL

RO SI

SK

%

22

THE CRISIS: SUDDEN STOP OF CREDIT

LOAN TO DEPOSIT RATIOS OF EU BANKING SECTORS

0

50

100

150

200

250

300

350D

enm

ark

Latv

ia

Sw

eden

Est

onia

Lith

uani

a

Irela

nd

Slo

veni

a

Hun

gary

Finl

and

Italy

Por

tuga

l

Rum

ania

Fran

ce

Bul

garia

the

Net

herla

nds

Spa

in

Aus

tria

Cyp

rus

Pol

and

Mal

ta

Ger

man

y

Gre

ece

Slo

vaki

a

Cze

ch R

epub

lic

Bel

gium

Luxe

mbo

urg

%

AVERAGE: 140.6%EMU AVERAGE: 112%

BALTIC STATES: 223%CEE6: 105%

The growth strategies built on cheap external financing are not sustainable any more

Domestic savings will not be sufficient to substitute external fundingSource: ECB, NBH, data as of end-2008

23

THE RISING RATIO OF FX TRANSACTIONS AND BOOMING FX LENDING IS A REGIONAL PHENOMENON

Small, open, export-driven economies, liberalized FX transaction among residents, and/or currency board or spontaneous euroization or the voluntary

interpretation of IT (high interest rate differential)

NO LENDER OF LAST RESORT

SHARE OF FX LOANS WITHIN THE BANKS' HOUSEHOLD LOAN PORTFOLIO

0102030405060708090

100La

tvia

Est

onia

Hun

gary

Lith

uani

a

Rom

ania

Pol

and

Bul

garia

Slo

vaki

a

Cze

chR

epub

lic

%

0102030405060708090100

%

2003 2008

Source: NBH

24

UNHEDGED FX POSITIONS

A natural consequence of the permanent external deficits in the region

Net domestic savings were insufficient to finance investments and exports, hence external capital inflows were needed to finance the deficit.

The debt-generating part of the capital inflows necessarily resulted in the formation of an unhedged FX position at one or more domestic agents.

The balance sheet of the banking sector purely mirrors the macro imbalances.

25

THE CRISIS: IS THERE A WAY OUT?

The region imported the financial crisis

Collapsing export markets: a huge shock to the real economy

Sudden-stop of capital inflows: financial sector shock

The room for fiscal maneuver is limited

The central banks are unable to provide the system with foreign currency liquidity

If –in the midst of the crisis-

• governments intend to improve external balances, to keep budget deficits under control,

•the banking sector aims for lower L/D rates,

•authorities, financial watchdogs demand higher capital adequacy ratios, impose limitations to FX lending

simultaneously, the result would be an even deeper recession

26

Due to the cross –border dependencies coordinated actions are needed

The problems can not be solved on a national basis

Governments, central banks in the region should act jointly with the ECB, the European authorities, international organizations and foreign owners of the

banking sector

Not to fund a credit boom, but

to create the conditions for a moderate 5-8% yearly growth rate in credit and avoid a long-lasting depression

THE CRISIS: IS THERE A WAY OUT?

27

DID THE EURO PROVIDE A SHELTER?

The EUR on its own was not able to provide a shelter

The ECB could have helped by providing EUR liquidity to the region

The main issue was:

Whether the given banking sector had a liquidity buffer?

Slovakia versus Czech Republic

The Czech Republic managed the crisis well and so did Slovakia.

The pace of GDP contraction is similar in both countries.

28

FUTURE CHALLENGES

Macroeconomic policies

The external deficits that had been considered sustainable before the crisis are no longer sustainable

The region will not be able to return to the growth levels seen before the crisis, economies should adjust to a lower path.

Germany: should take over as the „final consumer” of Europe instead of pushing ahead with a purely export-driven growth strategy.

29

Banking sector

L/D ratios should adjust, but it would be a mistake to target L/D at or even below 100%, as it would kill growth and convergence

Limiting FX based lending is acceptable only if medium and long-term domestic currency- based financing is available at a reasonable price

Killing FX-based lending and at the same time not providing domestic currency based financing would result in a prolonged economic stagnation

In an economy that is heading towards the euro, the dynamic expansion of CHF or JPY denominated loans in the household sector is clearly not a welcome

development (especially if these loans are short-term instruments), but there are serious arguments supporting EUR-based lending in case of mortgages and

investments

If the economy as a whole is on a sustainable path –primarily the external position is sustainable- the risk of the open, unhedged FX position is manageable, both on

a macro and on a micro level.

FUTURE CHALLENGES