East European Bankers Warn Bad Debt Thwarts Credit Recovery

Bad debt in eastern Europe, already exceeding a third of all lending in several countries, will stay at high levels and cast a pall over hopes of restoring credit growth, according to the region’s leading bankers.

Ukraine and Kazakhstan have the highest rates of loan delinquency at 33 percent and 35 percent respectively, according to data presented yesterday by UniCredit SpA, the biggest western lender in the region by assets. In Hungary, 20 percent of banks’ loan books are non-performing, while in Romania the figure is 26 percent. In Poland, which comes from a lower level, they have started to rise, UniCredit said.

Regulators and international lenders that have propped up countries in the region with emergency loans since 2008 are calling on banks and national watchdogs to resolve the bad debt issue by encouraging banks to write them off and move on. They cite past banking crises as evidence this is needed to kick-start lending and economic growth.

“There is a significant drag on credit growth in the form of high non-performing loans,” Piroska Nagy, director of country strategy and policy at the European Bank for Reconstruction and Development, said in an interview while attending a Euromoney conference in Vienna. “If it’s small, it’s a natural part of banking business. If it becomes a big part, it takes over the natural part of the banking business.”

Contagion Shield

Policy makers are trying to shield growth in eastern Europe against contagion from the euro area’s debt crisis. The economic malaise in western Europe has stifled exports from the former communist part of Europe, while new capital and liquidity requirements for western lenders controlling three-quarters of its banking system have curbed credit needed to fund the region’s companies and households.

Western banks that dominate eastern Europe will continue to shed assets to improve their balance sheets in the next two years, thus preventing a recovery in lending, Hungarian central bank Vice-President Ferenc Karvalits, said yesterday in Vienna.

“In lending activities, both on the corporate and retail side, credit conditions continue to be tightened,” Karvalits said. “Loan activities will recover only if the portfolios are sufficiently healthy. With such large non-performing portions, the recovery won’t be easy.”

UniCredit and its Austrian peer Raiffeisen Bank International AG both warned that bad debt wouldn’t drop materially any time soon.

Slower Growth

“Slower, but continued growth of NPLs and NPL ratios, also driven by lower lending growth, seems to be the most likely development,” Raiffeisen Chief Executive Officer Herbert Stepic told journalists yesterday. UniCredit’s Aurelio Maccario, head of central and eastern European strategic analysis, said bad-debt growth would slow.

Non-performing loans in central and eastern Europe are about 10 percent and their growth pace is moderating in the Czech Republic and Russia, Stepic said today in an interview in Vienna. “I hope we will see an easing of the non-performing loan development” this year and an improvement in 2014, he said.

While the ratio of delinquent loans is higher in eastern Europe than in western Europe, it also comes with greater potential for profit, which makes up for the increased risk, Stepic said.

‘Positive Effects’

“The positive effects of the earning possibilities are overcompensating the negative effects of the non-performing loans,” Stepic said. “Otherwise it would not have been possible that central and EEU-managed banks before Lehman and after Lehman offer a much higher return on capital than those banks that are operating in the EU. That’s what we shouldn’t forget.”

The Vienna Initiative group of banking regulators and international lenders such as the EBRD, the International Monetary Fund, the World Bank and the European Investment Bank, discussed how to deal with bad debt in eastern Europe at a meeting in Vienna on Jan. 14, the EBRD’s Nagy said.

“It’s also up to the regulators to give the right incentives, to clean up these non-performing assets and not allow them to be evergreened forever,” Nagy said.

Regulators should learn from past banking crisis cleanup measures such as those taken in Sweden, said Nagy. “We don’t have to reinvent the wheel, the instruments are there,” she said. “Otherwise you are going to go into the Japanese lost decade.”

Capital Reserves

For countries with bad debt levels above 20 percent, this would involve setting up bad-asset companies tasked with working out the loans, she said. The resulting bank losses could be buffered with existing capital reserves and provisions.

Despite the bad-loss burden, eastern Europe’s banking industry continues to show good profitability and will outperform its western European peers in the years to come, UniCredit said in a study presented yesterday.

“With an average return on equity expected at 10.9 percent in the years 2012-2015, the region will reveal an attractive and more sustainable double-digit profitability ratio than Western Europe,” the bank said.

No Deleveraging

Total banking assets in the region have grown even in the aftermath of the collapse of Lehman Brothers Holdings Inc. and Europe’s debt crisis, though at a slower pace, according to the study, released in Vienna. Total banking assets grew an average 7.3 percent per year to 2.9 trillion euros ($3.9 trillion) between Sept. 2008 and Sept. 2012, according to the study.

Cost efficiency and risk management will remain the determining factors for the banks’ performance in the region, UniCredit said.

A clear differentiation across eastern Europe is discernible, “with Turkey and Russia over-performing, while the profitability of the banking sectors in the Balkans and Ukraine is subdued,” it said. “Asset quality is a source of risk, at least until 2014.”

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