East Europe’s Bank Funding Shift Risks Credit Crunch: IMF

Eastern European banks reducing their reliance on volatile foreign funding may deepen a credit crunch and thwart the economic recovery if done too fast, the International Monetary Fund said.

Eastern European countries relied on foreign investment to reshape their economies during the transition from communist to free-market principles since 1989. While foreign ownership brought benefits such as better banking practices and access to credit, it also “extended economic booms only to be followed by deep recessions,” Bas Bakker, chief of the IMF’s emerging Europe division and his deputy, Christoph Klingen, wrote in a report published today.

Foreign lenders such as Italy’s UniCredit SpA and Austria’s Erste Group Bank AG, which own about three-quarters of banks in the continent’s east, are trimming financing and capital to their units as stricter regulations require them to repair balance sheets. While the shift to more local funding is “appropriate,” policy makers should avoid “ring-fencing” capital and liquidity, the IMF said in the report.

“The recent post-global crisis trend which is underway toward less reliance on foreign funding and its associated volatility is welcome,” Aasim Husain, deputy director of the IMF’s European Department, said yesterday during a conference call. “However, the process should neither go too fast nor too far, otherwise it risks crimping credit provision and economic recovery. One would also lose the benefits from financial integration.”

Western Funding

Financing from western banks to the region grew to about $1 trillion in 2008, from about $200 billion in 2002, representing a quarter of the area’s gross domestic product, the IMF said. About half was funding for lenders, mostly as loans, with the rest being cross-border credit to non-banking subjects, according to the Washington-based lender.

About a third of the boom-time inflows were withdrawn between 2008 and 2012, reflecting strains on western banks and sluggish credit demand amid an economic slowdown, the IMF said.

Policy makers should facilitate “an orderly” transition toward a more stable funding model by pushing ahead with the creation of a European banking union, improving the implementation of tougher regulations in the west and the east and removing obstacles to credit expansion, Bakker and Klingen wrote.

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