The
annual Transition Report from
the European Bank for
Reconstruction and Development
finds big improvements in the
former Eastern Bloc.
Eight years after the ruble
crisis sent shock waves across
Eastern Europe's financial
sector, banks in the region
are bigger, stronger, better
regulated, more profitable and
more competitive than ever.
This, more than any other
development in the economic
sphere, signals that market
forces have established a firm
footing in former command
economies. Most of these
"transition" countries are
booming, with bank lending a
big factor in current economic
growth rates that range from
over 6% in Russia and Serbia
to 5.7% in Ukraine and 5.5% in
Poland.
No longer constrained
within a socialist mono-bank
culture, the sector now boasts
a diverse range of
institutions. They provide
finance to aspiring
entrepreneurs, to larger firms
seeking to boost their
competitiveness, and to
households looking for better
lifestyles. Banks still
dominate, but the financial
sector is broadening thanks to
stock markets bolstered by
tougher disclosure rules,
pension funds promoting
long-term savings, and private
equity. Corporate governance
and transparency have
improved.
Economic Transformation
While much work still has
to be done, improvements in
the institutional environment,
privatizations, and the entry
by foreign banks into the
market all helped drive
change, particularly as
nations from Latvia to Poland
to the Czech Republic prepared
to enter the European Union (EU)
in 2004.
Now, banks in the
transition zone enjoy returns
on assets and on equity well
above the EU average, thanks
to booming economies and
reforms that have given banks
greater security in lending.
Lending in the region
increased on average by 20% in
2005, underscoring the role of
banking in the transformation
of the broader economy.
Deposits are rising in line
with domestic confidence in
economic stability and in the
financial system.
EU accession countries have
made the most progress in
reforming their banking
systems, but indicators in the
just released
Transition Report for 2006
also show upgrades over the
last year for Russia, Ukraine,
and Kazakhstan. Tajikistan and
Uzbekistan have improved as
well, albeit from lower
levels. Banks in most of the
region now enjoy better legal
protection, courts are better
at enforcing laws, and banking
supervision and regulation
have become more effective.
Better Ratio of Bad Debt
It's all a far cry from the
1998 ruble devaluation and
debt default, which led to
bank and business failures and
the evaporation of savings in
Russia and beyond. While still
vulnerable, the region's
financial institutions are
much better equipped to
weather a downturn in the
global appetite for emerging
market risk.
The ratio of bad debts to
total loans has improved
across the region. In the EU
accession countries, it is now
fast approaching the eurozone
average of 3.4%. In the
Commonwealth of Independent
States, the ratio has tumbled
from 18.5% in 2002 to 6.5% in
2005. And in the Balkans, the
ratio is falling but remains
high at 9.5%.
The presence of
foreign-owned banks—mainly
Swedish, Austrian, and
Italian, but also Citibank (C)
and GE Capital (GE)—which
control between 60% and 90% of
bank assets in most countries,
has helped to increase the
availability of credit,
boosted competition, and also
encouraged the widespread
adoption of better banking
technology and management
practices.
Pushing Household
Borrowing
However, the dominant role
of foreign banks has raised
some worries about the
possible knock-on effect in
transition countries of a
financial crisis in the
domestic economy of one of the
parent banks. The experience
of the 1997 Asian financial
crisis is instructive:
Japanese banks reduced their
lending across Asia in
reaction to an initial crisis
in Thailand. Fortunately,
evidence thus far suggests
that foreign banks in
transition countries can
actually help stabilize them
in times of crisis.
Another issue is that some
foreign banks are promoting
household borrowing much more
than lending to smaller
businesses, as individual
credit risk is easier to
assess than that of micro,
small, and medium-sized
enterprises (defined as firms
with up to 250 employees).
Indeed, consumer debt in some
countries is reaching Western
European levels. That said,
there has been an overall leap
in lending to smaller firms
which, with the right
financial backing, have the
greatest potential to create
jobs and wealth across these
emerging economies.
Micro, small, and
medium-sized enterprises are
now the single most important
customer category for almost
all types of banks studied in
the Transition Report's
Banking Environment and
Performance Survey. The shift
to supporting small business
reflects vital reforms in
financial laws and regulation,
particularly regarding
collateral pledges to secure
loans. Serbia's ProCredit Bank
reports that reforms have
allowed it to cut its time for
processing loans to small and
medium-sized enterprises from
10 days to one.
Limited Product Range
Of the 1,200 micro, small,
and medium-sized enterprises
surveyed in Ukraine, Russia,
Georgia, and Bulgaria, the
number receiving bank loans
doubled between 2001 and 2004.
Loan sizes increased by
one-third, interest rates fell
by 12%, and loan maturities
rose from 14 to 20 months.
Access to bank credit
increased average revenue
growth by 75% in the companies
polled.
Despite many improvements,
banking in the region
continues to lag far behind
Western Europe. For example,
the amount of bank credit
available relative to gross
domestic product in Russia is
one-sixth of that in Portugal.
In Croatia, it is one-third as
high. Many Russian businesses
are still completely outside
the formal financial system,
and the range of products
their banks offer is still too
limited.
Widening financial access
and deepening the financial
system requires a raft of new
measures. Banking supervision,
competition policy, and
creditor protection all should
be bolstered. The financial
sector must grow beyond banks
to more fully embrace other
sectors such as equity,
leasing, pensions, and
insurance. Governments and the
financial industry must play
their parts in ensuring the
sector is strong enough to
further underpin the growth
that is already improving
lives and bringing greater
stability to Eastern Europe.
Berglöf
is the chief economist and
special advisor to the
president at the European Bank
for Reconstruction and
Development in London.
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