Eastern Europe May Need Funding Deal to Avert Credit Drought

Eastern Europe may require funds from the International Monetary Fund and other international lenders to preempt a banking crisis and a shortage of credit in the region’s economies as western banks pare assets.

The IMF, the European Bank for Reconstruction and Development, the World Bank and the European Investment Bank, which spent $42 billion after the collapse of Lehman Brothers Holding Inc., should “stand ready to provide external assistance and financial support to banks,” the Vienna Initiative group of regulators and policy makers said in a statement after a meeting in the Austrian capital on Jan. 16. The risk of “excessive and disorderly deleveraging as well as a credit crunch” looms over the region, they said.

“There is a very strong impact from this -- a potentially strong impact,” EBRD’s Chief Economist Erik Berglof said in an interview during a Euromoney conference yesterday in Vienna. “You have the headquarters making decisions on assets that are very small when you look at the total balance sheet, but when you look at the subsidiaries in eastern Europe they are systemic in the countries where they operate.”

Regulators and policy makers are trying to shield economic growth in eastern Europe against contagion from the euro area’s deepening debt crisis. New capital and liquidity requirements for the western lenders controlling three-quarters of eastern Europe’s banking system threaten to curb credit needed to fund the region’s companies and households.

‘Especially Virulent’

Deleveraging by western European banks may make credit in eastern Europe scarcer, the World Bank’s Andrew Burns was quoted as saying in Austrian newspaper Wiener Zeitung today.

“The problem is especially virulent in eastern Europe and central Asia because those countries strongly depend on loans from developed countries,” Burns said.

A revival of the Vienna Initiative is needed because there must be a recognition that “there is still a coordination failure” between eastern and western Europe to tackle banking risks, Piroska Nagy, director of country strategy and policy at the EBRD, said at the Vienna conference.

The IMF, EIB, EBRD and the World Bank “will engage at a heightened level with the region,” Nagy said today in an interview, without elaborating further.

‘Talking About Change’

“Now we are talking about change, accommodating and financing change as opposed to maintaining support,” Nagy said. “There’s deleveraging, there’s recapitalization, regulatory changes, there’s a lot going on. Change is fine and good, but it has to be managed in a way that doesn’t cause systemic risks.”

UniCredit SpA (UCG), Erste Group Bank AG (EBS) and Raiffeisen Bank International AG (RBI), the biggest lenders in the former communist countries, are raising capital, shedding assets and tightening funding of subsidiaries to meet new rules imposed by the European Banking Authority and national authorities. Societe Generale SA (GLE), KBC Groep NV (KBC) and Intesa Sanpaolo SpA (ISP) are next in the ranking of eastern European banks.

Unicredit SpA, the largest lender in eastern Europe by assets, said today the need to pump money into the region wasn’t as pressing as it was three years ago when capital flows dried up.

“The major problem today is in western Europe rather than in eastern Europe,” Gianni Papa, who heads the Italian bank’s eastern European business, said in an interview in Vienna. “For the time being we think the risk of contraction is very limited. We don’t have to put in place very strong action as it was needed in 2008.”

‘Concern About Commitment’

“There is some concern about some of the big strategic banks in the region in terms of their commitment,” Berglof said.

By the end of June, European banks must have core capital reserves of 9 percent after writing down their holdings of sovereign debt, European Union leaders decided in October. That may require an additional 115 billion euros ($149 billion) of capital, according to the EBA.

Austria told its three biggest banks to limit lending in eastern Europe to 1.1 times the funding they can raise locally. It also imposed a capital surcharge whose size depends on their eastern European business. Austrian banks collectively are the biggest lenders in eastern Europe, and the risk they may need more state aid was the main reason cited by Standard & Poor’s in downgrading the country’s debt rating last week.

‘More Local Funding’

“For a long time the banks were simply a very important source for and channel of funds into the region,” the EBRD’s Berglof said. “We have to realize that cross-border banking isn’t going to be the same. We have to outline a path to more local funding of the banks.”

Austria’s financial market regulator, the FMA, told the European Commission that its plans to limit commercial banks’ east European lending involves no sanctions on banks that don’t comply, meaning there is no contravention of EU law, the Financial Times reported today, citing the FMA.

The international lenders, which had pledged 24.5 billion euros in 2009 to avert a systemic banking crisis in eastern Europe and eventually disbursed 33 billion euros, didn’t promise a specific fund this time.

“Vienna 2.0 is shaping up to be a damp squib,” said William Jackson, an analyst at Capital Economics. “While we think that the measures outlined are useful, we are somewhat skeptical about whether they would be sufficient in a worst case scenario. There is quite a sharp contrast between this announcement and that back in 2009, when the IMF et al. put almost 25 billion euros on the table.”

‘High Risk’

A “number” of countries in the East, including Hungary, Bulgaria, Croatia and Romania are “at high risk of a banking crisis,” Jackson said.

UniCredit needs 7.97 billion euros of capital, or equivalent asset cuts, to meet the new requirements, according to the European Banking Authority.

Erste, the region’s second-biggest, requires 743 million euros, while Raiffeisen, the third biggest, has a 2.1 billion- euro shortfall. While all of them have reiterated that eastern Europe is a central part of their business and they won’t abandon the region, they also said that they are raising their capital ratios at least partly by reducing assets.

‘Not Credit Crunch’

Banks may also reduce funding by as much as 30 billion euros this year, Raiffeisen board member Patrick Butler said at the Vienna conference, adding that this amount was small compared with how much was transferred to the region in the boom years until 2008.

“Compare that to the growth that we saw in 2006 or 2007 of 200 billion euros a year -- it’s minimal,” Butler said. “It is not a credit crunch.”

The Vienna group urged western European regulators and policy makers to align their demands to recapitalize banks and to consider the effects on subsidiaries in other countries.

“It is important that home country authorities internalize the cross-border effects on EU and non-EU countries in formulating their measures,” the group said in its statement. “In particular, the recapitalization plans of international banks submitted to the EBA should be scrutinized” for their “systemic impact on host economies.”

‘Excessive Reliance’

Eastern European regulators and central banks “should further the development of local sources of funding as market size permits so that banks can reduce excessive reliance on capital inflows,” the group said. “Information sharing between home and host authorities should be stepped up to avoid unnecessary ring fencing of liquidity.”

Their engagement prompted Austrian lenders, together with their Finance Ministry and central bank, to start the Vienna Initiative in 2009. The group helped stabilize the region that year by a collective commitment by the banks not to reduce their lending in the region, backed up by the international lenders’ funding program.

“At the time of Vienna One, there was this fear that the banks might withdraw liquidity rapidly,” Raiffeisen’s Butler said. “Vienna Two is much more a discussion among the regulators and the public sector to ensure there aren’t steps taken which will prevent the banks doing their job.”

To contact the reporters on this story: Boris Groendahl in Vienna at bgroendahl@bloomberg.net; Agnes Lovasz in London at alovasz@bloomberg.net

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

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