Europe’s Eastern Bailout

The Vienna Initiative has yet to produce a sustainable recovery in Central and Eastern Europe.


Just over a year ago, banks in Central and Eastern Europe were staring into the abyss. The financial crisis had brought an abrupt end to a decade of breakneck growth and exposed a dangerous dependence on overseas liquidity, and widespread currency mismatches that threatened a surge in loan defaults. A plunge in global trade had sent the region’s economies tumbling into the worst recession since the collapse of Communism in 1989. Bank executives and government officials feared that Western institutions, which control the bulk of CEE assets, might cut off funding for their Eastern subsidiaries to save their domestic businesses.

Today bankers and policymakers are breathing easier. A support program coordinated by the European Union, the European Bank for Reconstruction and Development and the International Monetary Fund, among others, has pumped more than €77 billion ($102 billion) into government coffers and regional banks, staving off the threat of widespread failures. The global recovery is beginning to feed through to local economies, especially those dependent on exports of oil and other commodities. And Western banks have stuck with the region, believing that the long-term growth prospects outweigh any short-term difficulties.

The unprecedented policy coordination, known as the Vienna Initiative, has succeeded in fending off contagion, says EBRD president Thomas Mirow. “There haven’t been major bank runs in the region, and none of the systemically important Western banks have withdrawn,” he says (see interview, below).

Erik Berglof, the bank’s chief economist, notes that European banks play a much bigger role in CEE economies than U.S. and Japanese banks did in Asia before that region’s crisis a decade ago. “We wanted to reinforce a collective incentive for the banking sector to stay engaged,” Berglof tells Institutional Investor. “That’s a core difference and explains why we didn’t have the meltdown that we saw in so many countries in Asia” in the late 1990s.

Notwithstanding the success of the initiative, however, the region has a long way to go to ensure a sustained recovery, both for the banking sector and for the wider economy. The EBRD predicts that growth will average 3.3 percent across the 30 countries in which it operates, from Central Europe to Central Asia, compared with a decline of about 6 percent in 2009, but the rebound will be very uneven. Commodity-based economies, led by Russia, should see the strongest growth, while countries such as the Baltic states and Hungary face another year of contraction, albeit at a much reduced rate. Lending conditions remain very tight in most countries as banks struggle with rising levels of bad and doubtful debts. Economists at Raiffeisen International Bank-Holding forecast that lending will increase in the high single digits this year, a recovery from last year’s depressed levels but a far cry from growth rates of more than 40 percent in countries such as Bulgaria, Latvia and Ukraine during the boom years of 2003–’08.


“The next three to five years could still be a very testing time for financial institutions in the region,” says Neil Shearing, an economist at the London-based research consulting firm Capital Economics Group. “There is a risk that as the dust starts to settle and problems close to home start coming to the fore, the Western banks will start to reassess their exposure to Eastern Europe.”

For now, though, lenders insist they have no intention of pulling back from the region. “We are long-term investors, and we want to stay there,” says Herbert Stepic, chief executive officer of Austria’s Raiffeisen International, the third-largest bank by assets in Central and Eastern Europe. The bank last month confirmed plans to merge with its unlisted parent, Raiffeisen Zentralbank Österreich, a move that underscores the group’s commitment to the CEE region. “We are absolutely convinced that Eastern Europe will get out of the crisis much faster than the rest of Europe,” Stepic says, citing the region’s faster productivity growth and attractive tax rates.

The crisis has underscored the mutual dependence between the economies, and the banking systems, of Western and Eastern Europe. Both areas saw economic activity and markets seize up after the failure of Lehman Brothers Holdings in September 2008. The following month Western European governments rushed to adopt bailout packages, including capital injections and loan guarantees, to shore up their banking systems, part of a coordinated effort by the Group of 20 to prevent a widespread financial collapse. The effort succeeded in the West but raised immediate fears in Central and Eastern Europe that the region could be cut adrift.

In early November, Stepic gathered top executives of five major Western European banks active in CEE at Raiffeisen’s Vienna headquarters to coordinate an effort to lobby government support for the region. In January, Thomas Wieser, director-general for economic policy at Austria’s Finance Ministry and then–vice president of the EU’s Economic and Financial Committee, convened a meeting in Vienna of officials from EU and CEE Finance ministries and central banks, as well as representatives of the EBRD, the IMF and the World Bank. At a follow-up meeting in March at the Joint Vienna Institute, a body that teaches Eastern Europe about market economics, the officials ironed out the details of a support program during a tense five-hour meeting.

The agreement, officially dubbed the European Bank Coordination Initiative, called on the EBRD, the World Bank and the European Investment Bank to provide €25 billion in equity injections, loans and political risk insurance to shore up banks in the Central and Eastern region and maintain the flow of credit to small and medium-size enterprises. Seventeen banks active in the CEE — including Italy’s UniCredit Group and Intesa Sanpaolo, Austria’s Erste Group Bank and Raiffeisen, France’s Société Générale and Sweden’s Swedbank and Skandinaviska Enskilda Banken — agreed to support and recapitalize their subsidiaries in Central and Eastern Europe. That accord was vital because foreign banks dominate the CEE economies, controlling between 60 and more than 90 percent of banking assets in most countries in the region.

In addition to the assistance from the multilateral banks, the IMF and the EU committed €52 billion in aid to several governments in the region, led by Hungary and Romania. In a separate but complementary move, EU countries agreed to double, to €50 billion, a balance-of-payments support facility to EU members that are not part of the euro area. “The availability of a larger amount of funds will make it easier for those countries to withstand financial pressures,” says Filip Keereman, head of a European Commission unit that monitors financial developments.

The EBRD, which was founded in 1991 to help the former communist countries transition to market economies, committed €6 billion as its share of the initiative, with most of the money supplied as loans to Western European banks. The bank has also stepped in to help rescue locally owned banks in Georgia, Kazakhstan, Latvia, Russia and Ukraine. Among its most prominent moves, the EBRD paid €84 million in April 2009 for a 25 percent stake in Parex Bank, the second-largest lender in Latvia; the government had nationalized Parex in 2008 when it was struggling to repay more than €700 million in syndicated loans.

The EIB, the world’s biggest development bank, is the Vienna Initiative’s largest backer. The Luxembourg-based EU bank agreed to extend €11 billion in loans to CEE banks, with about three quarters of the funds going to institutions in the EU’s ten member states in the region, as well as Albania and Serbia, and the rest dedicated to lenders in Turkey.

The World Bank is chipping in €7.5 billion for the region’s banking industry, a figure that includes loans to the governments of Hungary, Latvia, Romania and Ukraine that are conditional on financial industry reforms such as the preparation of stress tests for banks and the strengthening of out-of-court debt restructuring proceedings. The World Bank’s private sector lending arm, the International Finance Corp., is contributing an additional €2 billion, much of it invested in the equity and debt of local lenders, in trade finance and in buying bad loans from banks.

UniCredit, which has more than 4,000 branches in Central and Eastern Europe, the most of any foreign lender, has received about €2.5 billion as part of the initiative, says Federico Ghizzoni, head of banking operations in the region. The bank has used as much as 80 percent of those funds to provide loans to businesses and has put the remainder into infrastructure and other projects. “We got cheap funding that in turn we had to give to our customers,” Ghizzoni explains. “We are a vehicle to support the local economy.”

As significant as the initiative was, it hasn’t eliminated a credit crunch in the region. “The situation remains difficult,” says Marcis Dzelme, economics adviser at the Employers’ Confederation of Latvia. “On many occasions, financing conditions are tougher, and the money itself has been much more expensive. For the next two or three years, it will be a very slow recovery.”

The money committed jointly by the IMF and European Union was directed toward averting a balance-of-payments meltdown in Hungary, Latvia and Romania — which belong to the 27-member EU bloc — as well as in Serbia, which may join the EU in 2014, and in Bosnia and Herzegovina, a potential candidate for membership. Separately, the IMF has also granted bailout packages to countries including Armenia, Belarus, Georgia and Ukraine.

Officials in Central and Eastern Europe say the Vienna Initiative has prevented them from facing a deeper downturn. “It helped to rebuild the confidence in the Hungarian economy, and that helped to withstand the crisis,” says Peter Tabak, head of the financial stability department at Hungary’s central bank.

In November 2008, Hungary obtained a €25 billion loan package from the IMF, the EU and the World Bank to prevent a default on its foreign debt. The country’s economy is expected to shrink by less than 1 percent this year after contracting 6.3 percent last year, the most since 1991. OTP, the largest commercial bank in Hungary, took a €1.4 billion government loan backed by the IMF and secured a €220 million subordinated credit from the EBRD as part of the Vienna Initiative. The bank appears to have ridden out the storm. OTP, the only locally owned bank among the country’s top ten lenders by assets, in March reported a return to profitability in the fourth quarter, compared with a loss in the same period in 2008, and predicted that it would increase lending by 5 percent this year as the region’s economies recover.

Other countries are also edging away from the brink of a financial meltdown. The IMF expects Romania, which suffered its worst recession in at least 20 years in 2009, with a decline of 7 percent in GDP, to grow by 0.8 percent this year amid a revival in exports. But Romanian central bank officials say they do not expect the region to quickly regain its precrisis investor confidence. “That instinct that was saying, ‘Run from Eastern Europe’ has disappeared, but there is uncertainty about whether this means that investors will come back in big numbers,” says Valentin Lazea, chief economist at the National Bank of Romania in Bucharest. “There is no more fear, but the confidence is only now starting to grow.”

In addition to providing financial support, the EBRD and the IMF are also seeking to help Central and Eastern European economies become less vulnerable to future downturns. During a meeting on the Vienna Initiative in Athens in late March, officials decided to take steps to boost lending growth and bolster domestic capital markets in a bid to reduce CEE countries’ reliance on external financing.

The multilateral bodies are also working with governments in the region to regulate lending in foreign currencies, a practice that has worsened the fallout from the crisis. Such loans, usually denominated in euros or Swiss francs, became wildly popular in recent years as a means of enabling businesses and consumers to avoid high domestic interest rates and borrow at the low rates prevailing in the West. Foreign currency loans account for roughly 90 percent of total lending in Estonia and Latvia, 70 percent in Lithuania and more than 50 percent in Bulgaria, Hungary and Romania, according to Capital Economics’ Shearing. The crisis caused many local currencies to fall sharply against the euro, however, making loan repayments much more expensive for consumers and companies, and raising the risk of defaults. So far Hungary is one of the few countries that have tackled the issue, reducing loan-to-value ceilings to 60 percent for euro mortgages and car loans, and to 45 percent for loans denominated in other foreign currencies.

Some Western European banks aren’t waiting for regulators to act. Raiffeisen stopped making most foreign currency consumer loans, except for euro mortgages, two years ago. Société Générale, the fifth-biggest lender by assets in Central and Eastern Europe, is limiting Swiss franc and yen-denominated credit by running stress tests of customers’ ability to repay. “If we would lend more in local currency, we would need to have a very liquid and deep market offering instruments with long-term maturity,” says Jean-Didier Reigner, head of the bank’s operations in the region. “Today that does not exist. It will be the role of the different regulators to put in place.”

Bankers are optimistic about a lending revival. Société Générale, which got about €900 million in loans from the Vienna Initiative, expects to see demand for credit recover toward the end of this year, says Reigner. UniCredit aims to boost lending in Central and Eastern Europe by 10 percent this year, but Ghizzoni says that “demand is pretty low at the moment.”

The return of confidence, albeit tentative, has prompted Serbia to partly lift the obligation on foreign banks to maintain their exposure through 2011. Central bank governor Radovan Jelasic calls it an early test of the country’s exit strategy from the Vienna Initiative: “It’s an opportunity to see how banks are going to behave.”

Here the dilemma in the CEE is similar to that in much of the West. Although extraordinary support measures have bolstered banks and helped restore economies, it remains unclear how the market will fare when support is withdrawn. “There is no particular indication that we will need to recommit a significant amount of funds,” says Gerardo Corrochano, director of the World Bank’s private and financial sector for Europe and Central Asia. But, he adds, “I can’t rule out the possibility.”