Austrian Banks’ Bad Debt Eroded 65% of Profit Since 2008

Austrian banks must reconsider a business model that forced them to use 44 billion euros ($60 billion), or almost two-thirds of their profit since 2008, to provision for bad debts, the central bank said.

Austria’s largest banks, the biggest lenders in eastern Europe, must strengthen capital to catch up with competitors, cut costs and remain wary of the next bubble, Deputy Governor Andreas Ittner told reporters in Vienna today. If they do, the former communist part of Europe still offers more growth than their home market, he said.

“It’s not the time to pull out of eastern Europe,” said Ittner, who heads banking supervision at the central bank. “On the contrary, growth rates are still higher there than in western Europe, but it needs to be sustainable growth.”

Erste Group Bank AG, Raiffeisen Bank International AG and UniCredit Bank Austria AG expanded in former parts of the Hapsburg empire after the Iron Curtain fell. Rapid credit growth fueled bank earnings and economic growth until 2008 as clients borrowed to buy homes, cars and consumer goods. When economic growth contracted, bad loans and writedowns soared.

Erste continued its plunge today after it warned last week it will have a record loss from writedowns at its Romanian unit and set aside an additional 700 million euros for loan losses in Romania and Hungary. Bank Austria wrote off 2 billion euros of goodwill in March, and Raiffeisen warned of rising bad loan provisions in May, due to its Ukraine and Russia units.

‘Not Anymore’

Ittner, presenting his department’s semi-annual financial stability report, urged lenders to re-evaluate strategies prone to inflate bubbles and lead to an accumulation of bad debt. That includes providing subsidiaries with abundant funding from headquarters, often in foreign currency such as Swiss francs or U.S. dollars, instead of using local deposits and liquidity.

“What you can’t do anymore is like before the crisis, sell cheap bonds in the west and just pass this through toward eastern Europe,” Ittner said. “It was one of the mistakes, that by way of lending in foreign currencies they simulated interest rates that weren’t adequate for the local risk. Another issue was the pace of growth.”

While Austrian banks raised their aggregate Tier 1 ratio to 11.9 percent from 11 percent in 2013 as lenders including Erste and Raiffeisen sold new shares and bolstered their capital, they still lag European peers and the gap is widening, according to the central bank report. Meanwhile, Austrian banks’ cost-to-income ratio, a gauge of bank efficiency, is the highest in Europe after German banks.

“We continue to recommend a further improvement of the capitalization, which has become more and more a factor for banks’ competitiveness,” Ittner said. “And they need to do more about costs as well as about income and margins.”

Erste shares were down 2.3 percent at 19.04 euros at 5:13 p.m. in Vienna, the lowest in more than a year on an intraday level, after plunging 16 percent on July 4. The stock is down 25 percent this year, the biggest decline in the 30-company Euro Stoxx Banks Index.

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