Eastern Europe May Benefit From Some Bank Deleveraging, IMF Says

Eastern Europe would benefit from a “gradual” and “orderly” reduction of financing from western lenders that dominate the region’s banking industry, International Monetary Fund officials said.

While the “era of generous funding” by western banks to units in the east “is over,” the sale of assets, raising capital and reducing loans by parent banks shouldn’t lead to a credit crunch, Bas Bakker, head of the emerging Europe division at the IMF’s European Department, and Christoph Klingen, his deputy, wrote in the fund’s official blog on its website.

Eastern Europe relies on financing from western lenders such as UniCredit SpA and Erste Group Bank AG that bankrolled eastern Europe’s boom until the 2008 global crisis halted capital flows. Funding from western lenders added 1.5 percentage points of annual growth between 2003 and 2008 in the countries that joined the European Union in 2004 and 2007, the IMF says.

“Given the tremendous credit boom many countries in emerging Europe went through between 2003 and 2008, some gradual and orderly deleveraging of western parent banks would not be a bad thing,” Bakker and Klingen wrote. “It would help reduce the still high external debt in many countries. But orderly and gradual are the key words.”

Foreign banks have lent the equivalent of as much as 60 percent of gross domestic product to countries in the region, the biggest recipients being Croatia, Latvia, Slovenia and Estonia, with the average at 27 percent of GDP, according to Bank for International Settlements data cited by Bakker and Klingen.

Funding Cuts

Western lenders, squeezed by deteriorating loan quality and slowing economic growth as the euro-region turmoil spreads, are cutting funding to their eastern units as stricter regulatory requirements force them to sell assets and bolster capital.

A credit crunch can be avoided if western lenders cut back their exposures gradually and domestic deposits, other banks and local financial markets “fill the void,” Bakker and Klingen wrote.

Before the European Central Bank’s longer-term refinancing operations in December and February improved liquidity conditions, western banks reduced their funding to lenders in the region by 8 percent in the second half of last year, they wrote.

At the same time, eastern European banks collected “substantial” domestic deposits, resulting in an increase of funding across the region, except in Slovenia and Hungary, according to Bakker and Klingen.

Policy makers and regulators should facilitate this trend by maintaining high requirements for liquidity and capitalization, finding ways to reduce “still high” non-performing loan levels and promoting local-currency financial markets, they wrote.