The business model is being reshaped, but CEE banking remains an opportunity
- In the post-crisis environment, the higher cost of liquidity and risk necessitate a reshaping of the banking model,toward diversified lending strategies and a focus on sustainable growth
- The "economic convergence" and the "financial penetration gap" stories still apply, remaining the drivers of upside potential for CEE banking
- Access to capital and funding, good positioning and risk appetite are decisive for success in CEE banking. UniCredit confirms its commitment to the region, which is the Group engine for growth
Although Central and Eastern Europe were hard hit by the crisis, banking in CEE remains an opportunity. This is one of the key findings of the latest CEE Banking Study, conducted by UniCredit´s CEE Strategic Analysis department. The "financial penetration gap" and the "economic convergence" stories remain intact on a medium- to long-term perspective, providing the basis for an upside for banking in CEE. However the banking business, which in the past was to a large extent externally financed, has to be reshaped. The focus is gradually shifting toward more long-term sustainable growth, while risk control and efficiency remain in the spotlight. Risks remain, including challenges arising from the regulatory side.
Economic convergence and financial penetration gap stories still apply
After expected average growth of 3.6 percent for the CEE region in 2010, UniCredit researchers forecast growth to accelerate to some 3.8 percent in 2011. At the same time the growth outlook will vary significantly, with Central Europe, Turkey and the CIS gradually back on track, while South Eastern Europe is still lagging behind and addressing some necessary restructuring issues.
"The crisis did not affect CEE's long-term potential related to the 'convergence story'", said Gianni Franco Papa, new Head of CEE Division at UniCredit, "The regional growth model, based on capital inflows, growing competitiveness and improving standards of living is intact. And the same is true for the gap in the penetration with banking services". For example, mortgage financing penetration relative to GDP is expected to have approached the level of 8 percent in 2010. This compares with a ratio of 40 percent in the Euro area and indicates that market potential still exists. The catch-up potential is also evident on the corporate side, with loans to the corporate sector at 26 percent of GDP in CEE as compared to 52 percent in the Eurozone and the financial services offer to corporate clients still much less deep and diversified than the one which is common in more mature markets.
Both the convergence and the financial penetration gap stories provide the base for the expected upside in banking business in CEE in the medium to long term. CEE banking will continue to grow faster than in more mature markets, however, potential growth will remain below pre-crisis levels, as all convergence drivers will be less influential than in the past.
"A rebalancing of the macroeconomic model implies a changing banking model", stated Debora Revoltella, Head of CEE Strategic Analysis at UniCredit Bank Austria, "Pre-crisis CEE banking was based on rapid lending growth, which was to a large extent externally financed". Leveraging on abundant international liquidity and low cost of country risk, local banks were able to support growth by financing domestic lending via international capital inflows in the context of low domestic saving rates. Both, retail and FX lending boomed. "Given the higher cost of funding and the increased cost of country risk today, there is a need for a stronger focus on domestic funding. Moreover lending strategies might become more diversified and more supportive for long-term economic growth in the future, meaning less consumer credit lending at least in the ongoing phase of recovery and more corporate lending, particularly toward the export-oriented - productive sectors" said Revoltella. Given these circumstances, corporate lending should become the engine for long-term competitiveness and growth in the region.
The short-term outlook is improving but risks remain
The economic crisis was reflected first in a liquidity crunch, followed by rapidly multiplying credit quality problems, accompanied by a credit crunch. In line with economic recovery, the second half of 2010 witnessed stabilisation in the dynamic of problematic assets, reinforcing signs that the peak in terms of non-performing loans might be reached between the end of 2010 and the beginning of 2011. "In terms of banking profitability 2010 proved to be equally as challenging as 2009, as some moderately lower provisioning requirements were offset by a lower revenues generation capacity", reckoned economist Debora Revoltella. "Full recovery from the demand side will be essential, before we may see an acceleration in lending activity and banking business in general." She expects strengthening in banks' revenues generation capacity in 2011, all around the region, but notes that the pattern of recovery will remain moderate.
Hand in hand with changes in the competitive landscape in global banking, the tougher post-crisis banking environment in CEE may drive further changes. While the international investors who have been active in the region in the last decade reconfirm their strong commitment to CEE, the search for optimal positioning could result in M&A activities or asset swaps, while newcomers in specific markets and at the regional level are already indicating their interest.
"In this context, when distinguishing among the international players active in the region, the ability to leverage on a solid funding base and capital position, good access to international markets and favourable positioning, will increasingly become key success factors", said Gianni Franco Papa, Head of CEE Division of UniCredit. As UniCredit economists already stated last year, risk appetite is also crucial, making the difference between winners and losers. Papa regards UniCredit Group as well positioned to take advantage of the region's further recovery. Availability of capital and funding (including the Group's intention to allocate more capital to CEE), the widest network with strong positioning in the most dynamic markets in the region and good capacity to leverage on Group competences are the basis for future success.
Challenges ahead for the region's banking industry include growing national and international regulatory pressures. In the short term concerns are related to the strong focus on regulating the FX business, as well as the implementation of overly demanding levies on banks. In the medium term the challenge is Basel III implementation. "While regulation is welcome in the aftermath of the crisis, the fear is that it might end up penalizing with excessive boundaries the cross-border banking model, which has been the base of economic and financial convergence in CEE", said Revoltella.
Vienna, 19 January 2010
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