BANKING ON THE FUTURE
This conference session, including questions for discussion by the guest panel members, is based on the following background information:
- Maintain or Gradually Increase Interest Rates
- Monetary and Fiscal Policies
- Outlook for Balkan Banks
- Turkey’s Banks
- Greek Banks
- The Impact of the Greek Banking Crisis on Balkan Banks and the Risk of Contagion
- Investment Banking: Balkan Stock Markets
Maintain or Gradually Increase Interest Rates
On 23 October 2015, the People’s Bank of China (i.e. China’s Central Bank) cut its interest rate for the 6th time in one year. On 9 October 2015, the International Monetary Fund concluded its annual meeting in Lima with a warning to Central Bankers that the world economy risks another crash unless they continue to support growth with low interest rates. The IMF said that uncertainty and financial market volatility have increased, and medium-term growth prospects have weakened. Yet, four former Central Bank Governors responded to the IMF’s message with a warning to current policymakers that they risked sowing the seeds of the next financial crisis by prolonging the period of ultra-low interest rates. In a study delivered to the IMF’s annual meeting, the G30 group of experts who contributed to the study said keeping the cost of borrowing too low for too long was leading to a dangerous buildup in debt. The study was written by four former Central Bank Governors, including Jean-Claude Trichet, former President of the European Central Bank, and Axel Weber, former President of the German Bundesbank, and now Chairman of UBS.
The report stated: “The supportive actions by Central Banks can be useful, but there are serious risks involved if governments, parliaments, public authorities, and the private sector assume Central Bank policies can substitute for the structural and other policies they should take themselves. The principal risk is that excessive reliance on ever more Central Bank action could aggravate the underlying systemic problems and delay or prevent the necessary structural adjustments.”
In view of the current global economic conditions and the reliance of Balkan economies on international trade and foreign investment, this session will explore the experts’ assessments of the potential benefits and risks to Balkan national economies in the two possible cases of (i) maintaining low interest rates and (ii) gradually rising interest rates during the forthcoming year.
Monetary and Fiscal Policies
Through the use of monetary policies and recently enhanced financial stability mechanisms, Central Banks are the principal players in the development of financial and capital markets, and more broadly, sustainable economic development. Among their myriad of available tools, Central Banks can provide funds at below-market rates to encourage targeted lending or to complement existing priority lending targets. Central Banks can stimulate markets through asset purchases thereby releasing cash into the financial system; however, as the aforementioned study by the four former Central Bank Governors stated, there are limits to what Central Bank monetary policies and complementary measures can accomplish in providing a foundation for the stability and development of capital and financial markets and sustainable economic growth.
Monetary policies combined with effective fiscal policies, which can achieve optimum results if they are coordinated, can support economic stability and development aims, especially including employment growth which is one of the most important issues in the region today. National governments have the authority to implement a variety of fiscal policy actions. For example, they can: determine national debt levels, raise or lower taxes as well as government spending, establish incentives for foreign direct investment, implement debt reduction plans, establish fiscal stimulus programmes or austerity measures, and so on.
This panel discussion will explore: key monetary policies that have been most effective in support of national economic recovery and stability, the fiscal policies under national government jurisdiction that would effectively support Central Bank monetary policies in order to create a synergistic effect in boosting economic recovery and development, fiscal policies that would be best avoided in the near term because they might inhibit economic recovery and growth, and whether fiscal policies associated with national debt reduction and austerity measures during this fragile global economic recovery period hinder or support economic recovery and growth.
Outlook for Balkan Banks
Moody’s Investors Service recently published “Banking in the Balkans” which reported that Balkan banking systems have been recovering in line with analysts’ expectations of corresponding improvements in the region’s conditions for expansion of access to credit and available capital. The report states that the turnaround is being driven by gradual macro-economic recovery as a result of modest economic growth in Europe as well as the banks’ deployment of stronger liquidity and capital buffers thereby reducing the vulnerability of banks to the risk of collapse.
The report, which covers Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Kosovo, FYR Macedonia, Montenegro, Romania and Serbia (i.e. all Balkan countries except Greece and Turkey), states that credit conditions in these Balkan countries are expected to gradually improve against the background of modest economic growth; however, the rating agency’s forecast for economic growth over the next 3 – 5 years remains below the general levels of 4%-5% that had been achieved prior to the financial crisis.
This report also highlights the challenges faced by Balkan banks in their efforts to expand access to credit for consumers and businesses which, in turn, supports consumer demand and private sector investment that spur economic growth. These challenges are associated with the risks inherent in the quality of the assets in the financial institutions’ portfolios, notably the high percentage of non-performing loans (NPLs – loans past due for more than 90 days). While the creation of new NPLs is expected to continue to ease, Moody’s expects NPL ratios, which are currently ranging between 15%-20%, to remain stubbornly high as efforts to resolve the existing stock of NPLs have so far failed to yield effective and expedient results. Measures to reduce NPLs typically include expediting the sale of NPL collateral (which is property held by the banks as security for the loans), strengthening laws governing insolvency, and providing incentives to sell and/or write-off NPLs. Kosovo has shown progress in reducing its NPL ratio by introducing a private bailiff system that helps to enforce collateral recovery thereby reducing the country’s NPL ratio from from 8.3% in December 2014 to 7.1% in July 2015. Banking analysts have generally noted that ongoing risks associated with the quality of assets in the banks’ portfolios continue to adversely impact the profitability of Balkan banks due to high loan-loss provisioning requirements and subdued lending growth estimated at less than 5% for the region.
Significant Balkan bank stocks of foreign currency denominated loans to unhedged domestic borrowers represent a risk to the banking sector. For example, the average share of foreign currency denominated loans in Serbia was roughly 65% in mid-2015 according to World Bank Group data. Many of these loans are denominated in Euros. Although the euro is a global currency that is entitled to be freely traded internationally, Balkan banks are also subject to a risk associated with the region’s extensive use of the euro which is often used as a substitute for local currencies in certain transactions (e.g. loans denominated in euros), and in some cases the euro is used in the absence of a domestic currency. While this practice is conducted in certain countries, such as Montenegro and Kosovo which use (but do not issue) the euro as a de facto domestic currency as they have no agreements with the EU, use of the euro can generate significant credit risks to banks from the perspective of foreign currency lending to unhedged borrowers and constrains the ability of central banks to act as lenders of last resort. In these cases, Balkan borrowers whose loans are denominated in euros but who repay their loans from their domestic currency earnings will face much higher loan repayment amounts in the event that the value of the euro strengthens. This creates a risk of NPLs as the domestic currency value declines in relation to a strengthening euro value.
Regional banks are credited with having taken steps to reduce their vulnerabilities through de-leveraging in order to meet the higher capital and liquidity requirements, increasing local deposits and participating in the European Bank Coordination (“Vienna”) initiative, which brought together public and private-sector stakeholders to manage risks facing regional emerging market banks during the global financial crisis.
Among analysts current recommendations, Balkan banks are advised to:
- improve their data management and risk monitoring systems through the availability of advanced IT systems; and
- ring fence the most vulnerable parts of their operations, especially including retail banking which would serve to reduce the potential for conflicts of interest and increase depositor protection from lenders’ riskier investment banking operations.
Turkey’s rapid economic growth since 2009 put a strain on the banks’ ability to fund their lending from customer deposits alone. This required Turkish banks to supplement their capital available for lending by turning to international investors to make up the difference. According to analysts, this reliance on funding by capital markets exposes the country’s banks to risks associated with the anticipated rising costs of capital in global markets, subdued economic growth, currency exchange rate fluctuations and investor confidence. These factors limit growth opportunities for banks and impact borrowers’ ability to service their loans.
The asset quality of the banks’ portfolios are expected to decline moderately. Although analysts acknowledge that Turkey’s banks currently have a relatively low level of non-performing loans (NPLs), this is expected to rise principally among the banks’ consumer and SME borrowers. In early 2015, banking analysts reported that NPLs were expected to reach 3-4% of total assets. Corporate loans that have until now been fairly resilient to the economic slowdown are now considered to be vulnerable to exchange rate volatility because 88% of the enterprises with corporate bank loans have cash flow operations that engage in foreign currency exchange. This volatility was demonstrated during the first quarter of 2015 when the Turkish lira lost 20% of its value against the US dollar. As 40% of Turkish exports are destined for the EU which continues to exhibit sluggish growth, this devaluation of the lira was not able to provide a concommitant stimulus to Turkey’s exports.
One important factor associated with the resilience of the banking industry is that the banks remain well capitalised as Tier 1 capital across the banking sector stood at 14.0% of the banks’ risk-weighted assets at the end of 2014, which is up 1% from the previous year. Access to credit though, while expanding, is expected to do so at a slower rate than in previous years with moderate credit growth anticipated to be in the range of 14%-17% in 2015 compared to the 20%-30% growth of credit access during 2011-2014.
The profitability of Turkish banks will be affected by slower lending growth, the country’s persistently high inflation rate, and the narrowing of net interest margins caused by rising borrowing costs in capital markets as well as the short-term nature of their liabilities which will require frequent refinancing on terms that may be less favourable. Investor confidence is expected to be affected by the slower economic growth outlook for the country which will impact the demand for banking services.
During the first half of 2015, Greek banks experienced accelerated deposit outflows, a deterioration of bank funding and liquidity, the need for re-capitalisation, deteriorating credit conditions associated with capital controls, significantly reduced domestic economic activity, reduced investor and depositor confidence, and a fall in bank share prices. These losses have been attributed to a range of inter-related economic and political factors, not the least of which was uncertainty regarding the country’s future retention of the euro or return to the drachma as its domestic currency. Specifically, bank depositors expressed concern about the prospect of a forced re-denomination of their deposits into a new currency, in consequence of which domestic private sector deposits declined by €44 billion in the 7 month period from December 2014 through June 2015 according to Moody’s Investors Service in July 2015.
In addition to the foregoing, the IMF and ECB report that Greece’s non-performing loans (NPLs) are one of the banking system’s most serious problems. In 2014, the IMF calculated that Greek NPLs and restructured loans, which have a very high risk of renewed default, amounted to 40% of total loans – the highest level in reported history. In monetary terms, the NPLs of the top 4 Greek banks (which control 95% of all Greek market loans) consisted of €70 billion in NPLs in the Greek market and €10 billion of NPLs in their foreign subsidiary market – €80 billion in total. The sources of the NPLs are corporate loans (54%), mortgage loans (33%) and consumer loans (13%). According to Benoit Coeure (ECB Executive Board Member) in August 2015, NPLs at Greek banks are likely to increase in the next few years.
All of the foregoing factors have necessitated a significant re-capitalisation of the banks that will allow the resumption of loan operations which are essential to spur much-needed economic growth. Current capital controls, which are decided upon by the Greek government and not the ECB, are unlikely to be lifted prior to sufficient re-capitalisation, the expected date of which remains uncertain.
The Impact of the Greek Banking Crisis on Balkan Banks and the Risk of Contagion
Before 2009, Greek banks expanded aggressively into south-eastern Europe. Local subsidiaries of leading Greek-owned banks now play an important role in the financial sector in several Balkan countries, particularly Bulgaria, Romania, Albania, FYR Macedonia, and Serbia. According to The Economist in June 2015, Greek banks then accounted for 22% of total banking assets in Bulgaria, 12% in Romania, 16% in Albania, 20% in FYR Macedonia and 14% in Serbia.
Due to concern about the potential exposure of Balkan subsidiaries of Greek-owned banks to risks associated with the 2015 Greek banking crisis, certain Balkan central banks implemented measures to ring-fence the operations of Greek-owned bank subsidiaries from the operations of their parent institutions. In most cases, these subsidiaries are essentially separate legal entities from their parent banks in Greece as they are subject to domestic banking regulations including liquidity requirements.
In June 2015, Reuters published a report on the extent of Greek ownership of banks in the above-referenced countries as well as some of the measures taken by the countries’ central banks to insulate their banking systems, including the operations of their countries’ Greek-owned bank subsidiaries, from contagion during the Greek banking crisis that began in 2015. The following is derived from this report as well as national government sources and industry analysts:
Greek-owned banks that comprise one fifth of the Bulgarian banking system include United Bulgarian Bank which is Bulgaria’s fourth largest lender and is owned by the National Bank of Greece, Postbank which is Bulgaria’s fifth largest lender and is controlled by Eurobank Ergasias S.A., Piraeus Bank Bulgaria which is Bulgaria’s ninth largest lender and is controlled by Piraeus Bank of Greece, and Alpha Bank which is a direct bank unit of Greece’s Alpha Bank.
The Bulgarian National Bank (BNB), which is the country’s central bank, implemented measures to insulate Greek-owned banks in Bulgaria from contagion. The BNB said that these banks are financially independent from their parents, are not allowed to hold Greek government securities, are required to maintain higher deposits with the central bank, are restricted in the amount of funds that can be transferred from local subsidiaries to their parent banks in Greece, and have higher capital adequacy ratio and liquidity requirements than non-Greek-owned banks in the country.
There are 4 Greek-owned or controlled banks in Romania and together they account for 12% of total banking assets in the country: Alpha Bank Romania, Piraeus Bank, Bancpost controlled by Eurobank Ergasias S.A., and Banca Romaneasca controlled by the National Bank of Greece.
The National Bank of Romania, which is the country’s central bank, reported that the Greek-owned bank subsidiaries in Romania are well capitalised, and mid-year data reflected that their average capital adequacy ratio was slightly above 17% – in excess of the 10% capital adequacy ratio requirement set by the regulator. The banks’ portfolios of state securities entitles them to resort to funding from the central bank if needed. All bank operations in Romania are integrated in the Romanian banking system and regulated by the central bank; therefore, the capital controls imposed by the Greek government do not apply.
There are 3 Greek-owned banks in Albania: National Bank of Greece subsidiaries, Piraeus Tirana Bank, and Alpha Bank. Their share of the total assets of the banking sector in Albania was 15.9% in June 2015, down from 20% in 2010. One of the principal measures enacted by the Bank of Albania, which is the country’s central bank, on Greek-owned banks in the country was to raise the minimum capital adequacy ratio to 14% which is higher than the 12% minimum required for other banks. At the time, the 3 Greek-owned banks had a capital adequacy ratio of more than 17%. The Bank of Albania also restricted the transfer of funds from Greek-owned banks in the country to their parent organisations to ensure the stability and liquidity of the Albanian banking system. One result of the Greek banking crisis is that a portion of the capital and deposits from Greece were transferred to Albania, according to Bank of Albania Governor Gent Sejko. Remittances in the first quarter of 2015 were €146.7 million, up from €118.4 million in the same period in 2014. Some of the 600,000 Albanians living in Greece traveled to their home towns in Albania to conduct their banking and access their cash in branches based there.
FYR Macedonia has 2 Greek-owned banks which together hold slightly more than 20% of total banking sector assets. They are Alpha Bank AD Skopje which is a subsidiary of Alpha Bank, and Stopanska Banka AD Skopje which is owned by the National Bank of Greece.
The National Bank of the Republic of Macedonia (NBRM), which is the country’s central bank, required banks in the country to withdraw all deposits and loans from Greek-owned banks regardless of the agreed maturity and imposed temporary limits on capital outflows from Greek-owned bank subsidiaries in the country to parent banks in Greece. In addition, under FYR Macedonian law, the Greek parent banks are prohibited from withdrawing more than 10% of their founding capital in their subsidiaries, unless they sell their holdings to another investor. The minimum capital adequacy ratio for Greek-owned banks in the country was set at 13%, higher than the norm. The NBRM also receives daily notification of all transactions between Greek banks and their local units as a precautionary, risk management measure.
Standard Bank conducted an analysis of the potential “worst case scenario” in the event of unsustainable deposit withdrawals from Greek-owned banks in FYR Macedonia. Standard Bank reported that the national government was in a safe position to provide the estimated €250 million (representing 3% of GDP) that would have been required to fully re-capitalise the affected banks.
In Serbia, 4 Greek-owned banks hold $4 billion worth of assets, which represent 14% of total banking assets in the country: Alpha Bank, EUROBANK EFG, Piraeus Bank and Vojvodjanska Banka which is part of the National Bank of Greece group.
The National Bank of Serbia (NBS), which is Serbia’s central bank, increased its monitoring of the Greek-owned banks and requires daily reports, with a focus on the banks’ liquidity levels, flow of funds to the parent banks, and outflow of savings. The NBS also imposed restrictions on funding transactions between the Greek-owned bank subsidiaries in the country and their parent banks with strict limits on the repatriation of capital assets of the subsidiaries to the parent organisations. The capital adequacy ratio of Greek-owned subsidiaries was set at 20% – higher than the international norm of 8% – for the protection of depositors and to ensure the stability of the banking system.
Notwithstanding the foregoing, debt to deposit ratios of Greek-owned banks in the Balkans are often higher than average. In 2015 in Bulgaria, for example, the debt to deposit ratio of the Bulgarian subsidiary of Alpha Bank is 176.8%, which is more than twice the sector average of 88.3%. Postbank, a subsidiary of Greece’s Eurobank, has a debt to deposit ratio of 94.8%. Piraeus Ergasias Bank, the first foreign bank to enter the Bulgarian market, holds a debt to deposit ratio of 118.4% while the United Bulgarian Bank, which is 99.9 % owned by the National Bank of Greece, holds a debt to deposit ratio of 102.2%. This factor is considered during an assessment of whether a bank is well positioned to cope with a funding crisis.
According to The Economist’s June 2015 report, taking all factors into consideration, Croatia and Serbia are deemed to be the Balkan countries with the most exposure to indirect contagion effects due to their large fiscal and external financing requirements while Bulgaria, Romania and Serbia are deemed to have a direct exposure given their large banking sector linkages with Greece.
Investment Banking: Balkan Stock Markets
Stock exchanges serve many purposes, including (a) corporate financing beyond what is available from bank financing, (b) the refinancing of national government debt through the sale of government bonds which assists governments in financing their internal borrowing requirements, and (c) a venue for investment trading by individual investors, institutional investors such as pension funds, and others.
Balkan stock markets only began trading activities with a small number of stocks in the mid 1980s-1990s and, therefore, have a brief history compared to the older and more developed stock markets of Europe, Asia and North America. As the Balkan economies instituted market-oriented, economic structural reforms, the region experienced growth rates exceeding the EU average. Balkan economic growth, low interest rates (which enhances corporate earnings expectations) and a decrease in inflation resulted in a massive shift by investors from deposits and interest-bearing debt to equities thereby increasing capital inflows to the Balkans.
As an example of regional stock price growth rates, from 2000-2006 Balkan stock market prices increased on average more than 70% in dollar terms compared to the average 15% increase in world stock market prices. Among the Balkan stock markets, Greece, Turkey, Romania, Bulgaria, Serbia and Croatia are considered among the most developed in terms of regulation, capitalisation, turnover and market return; however, differences nevertheless remain in these areas between Balkan stock exchanges and their more developed international counterparts.
Balkan stock markets today remain relatively small in terms of capitalisation, turnover and liquidity. In contrast to developed stock exchanges, institutional investors represent a small percentage of investors in Balkan stock markets, with the exception of the Hellenic Exchanges S.A. (Athens Stock Exchange) and the Istanbul Stock Exchange, in the latter of which institutional investors own more than 50% of the freely traded shares. However, prospects for the Balkan stock exchange markets are improving due to the vast restructuring effort in public and private sectors, the expectation of EU membership accession, the increased value of institutional investors’ assets and improvements in investor protection.
It is characteristic in the region that the German stock market has a greater influence on the Turkish and Croatian stock markets than the remaining Balkan stock markets, while the Athens Stock Exchange plays a leading influential role among the Bulgarian, Romanian and Serbian stock markets. This is due to the historical ties between Greece and other Balkan countries, the extensive level of trade and the strong financial penetration of Greek firms in the region.
It is essential that all global judicial and stock exchange oversight institutions keep up to date with the rapidly-changing financial complexities of the industry to ensure effective regulatory enforcement. According to analysts, the productivity, profitability and investor confidence in Balkan stock exchanges would benefit from measures that will enhance the regulatory framework and supervisory process in the Balkan stock exchanges in order to (i) expand the range of tradable securities, (ii) increase financial information disclosure and transparency about corporate activity to investors which will bolster investor confidence, (iii) increase the liquidity of stock investments so that investors can easily and expediently convert their shares into cash by improving trading techniques, computerised trading and settlement systems, (iv) reduce stock market volatility, (v) provide investor protection in the event of brokerage firm defaults, and (vi) improve portfolio diversification as well as risk management.