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Euro Break-Up Firewalls Difficult to Build in East, Capital Says

Eastern European policy makers would struggle to build firewalls against contagion from a disorderly break-up of the euro because of short-term debt owed to western parent banks in foreign currencies, Capital Economics Ltd. said.

In a worst-case scenario following a potential Greek exit from the euro, eastern European nations may need to resort to International Monetary Fund aid, Neil Shearing, chief emerging-markets economist at London-based Capital, wrote in an e-mailed note today. Strategies such as the Vienna Initiative and swaps with the European Central Bank have “significant barriers” as western lenders are “in the eye of the storm,” he wrote.

Eastern Europe relies on financing from western lenders such as UniCredit SpA and Erste Group Bank AG, which own three-quarters of the region’s banking industry. The banks are already cutting funding to their eastern units as stricter regulatory requirements force them to sell assets and bolster capital.

“If these lines of credit are severed, local banks will struggle to roll over maturing liabilities, resulting in a potentially catastrophic credit crunch in the region,” Shearing wrote. “There is a clear risk that, should the euro crisis get messy, emerging Europe may yet find itself caught in the crossfire.”

During the global credit crunch that followed the collapse of Lehman Brothers Holdings Inc., the Vienna Initiative group of international lenders, governments and regulators persuaded western banks to roll over funding for their eastern units and inject fresh capital if needed.

International Funding

The IMF, the European Bank for Reconstruction and Development, the World Bank and the European Investment Bank provided $42 billion loans and investment for the largest banking groups to help the flow of credit to the economies.

While the ECB provided liquidity lines to both Hungary and Poland in 2008-2009, eastern central banks may find it difficult to open swap lines again because of the ECB’s reluctance to take zloty or forint assets onto its balance sheet, Shearing wrote.

An attempt to rekindle the Vienna Initiative earlier this year yielded “little more than a series of loose assurances on close co-operation between banks and governments,” he wrote.

Within the region, Hungary and the Balkans look the most exposed to the risks of spillovers, according to Shearing.

Foreign banks’ exposure to emerging Europe fell by less than 3 percent in the last quarter of 2011, about half the drop recorded in the previous three months, the EBRD said in a May 18 report, citing data from the Bank for International Settlements.

In central Europe and the three Baltic nations, cross-border bank claims dropped by about 5 percent in both the third and fourth quarters, BIS data show, according to the report.

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