Research on EU 10 economies and their banks

IMF delays loans to Latvia

2009-04-07T13:44:00.000+02:00

The International Monetary Fund has suspended lending to Latvia until it sees more progress in cutting public spending, the Latvian government confirmed on Thursday.

Latvia is racing to prepare more cuts to keep its €7.5bn ($9.9bn, £6.9bn) stabilisation plan on track and dispel fears that it will be forced to abandon its peg to the euro and devalue the lat, after the IMF postponed transferring about €200m last month.

“The first review has not been completed,” the IMF said. “This must be completed before the executive board can approve the disbursement.”

The news caused the cost of insuring Latvian debt against default to rise 71 basis points to 930. The credit default swap spread is regarded as a yardstick of confidence because the peg to the euro means the currency is little traded.

The second tranche of Latvia’s IMF loans has been postponed until June, when the government plans to put a new austerity package before parliament.

The budget deficit threatens to overshoot the target of 5 per cent of gross domestic product agreed with the IMF because the Latvian economy is contracting more severely than forecast.

The government now predicts the economy will shrink by 12 per cent this year – the worst recession in the European Union – compared with 5 per cent when the proposal to the IMF was drawn up in December. According to analysts, this could double the budget deficit to about 1.5bn lats ($2.8bn, €2bn, £1.9bn), close to 12 per cent of GDP.

The incoming government of Valdis Dombrovskis initially hoped to persuade the IMF to accept a slightly higher budget deficit of about 7 per cent of GDP and floated the idea of borrowing another €1bn from the international consortium that includes the European Commission, EU member states and financial institutions.

But an IMF mission to Riga, the capital, last week emphasised the need for reforms to achieve lasting reductions in the budget deficit, essential if Latvia wants to meet the conditions to enter the eurozone in 2012.

“This shows that the IMF is serious,” said Martins Kazaks, chief economist of Swedbank in Riga. “If you don’t solve the structural issues it’s not sustainable.”

The previous government slashed the wage bill for central government officials by 15 per cent but became mired in coalition disputes and collapsed in February.

The new government has asked ministers to put together proposals for cuts amounting to 20, 30 and 40 per cent of planned spending by mid-April.

IMF urges eastern EU to adopt euro

2009-04-07T13:34:00.000+02:00

From FT

Crisis-hit European Union states in central and eastern Europe should consider scrapping their currencies in favour of the euro even without formally joining the eurozone, according to the International Monetary Fund.

The eurozone could relax its entry rules so countries could join as quasi-members, without European Central Bank board seats, says the fund.

“For countries in the EU, euroisation offers the largest benefits in terms of resolving the foreign currency debt overhang [accumulation], removing uncertainty and restoring confidence.

“Without euroisation, addressing the foreign debt currency overhang would require massive domestic retrenchment in some countries, against growing political resistance.”

Disclosure of the confidential report, prepared about a month ago, could reignite a fierce debate over strategies to assist central and east Europe.

Even though global leaders hailed last week’s G20 summit as a success, eastern Europe’s challenges remain. Amid deepening recession, Ukraine and Latvia, two states already in IMF programmes, have in recent days balked at approving IMF-mandated reforms. A third, Hungary, is struggling to create a government capable of implementing reforms.

The IMF report was compiled to support a campaign by the fund, the World Bank and the European Bank for Reconstruction and Development to persuade the EU and eastern European states to back a region-wide anti-crisis strategy, including a regional rescue fund. The campaign failed amid widespread opposition from both west and east European states.

Eurozone members also oppose easing the eurozone’s entry rules, as does the ECB.

The IMF, which forecasts a 2.5 per cent decline in regional gross domestic product in 2009, estimates that “emerging Europe” – including Turkey – must roll over $413bn in maturing external debt in 2009 and cover $84bn in projected current account deficits.

The report estimates that “the financing gap” – money needed from international financial institutions, the EU and governments – will be $123bn this year and $63bn next, or $186bn in total.

Much could come from the IMF. But the report says “up to $105bn” could be needed from other sources, including the EU.

G20 and what is in it for EU10

2009-04-03T10:07:00.004+02:00

The G20 leaders agreed on their London summit to the following commitments:

Restore confidence, growth, and jobs by:

fiscal expansion in 2009 of up to $5 trillion, plus $1 trillion package added at the summit;
exceptional easing of monetary policy by central banks;
recapitalisation, liquidity and impaired assets removal from banks;
commitment to cooperation to return to trend growth;
promise of credible exit strategies to ensure long-term fiscal sustainability and price stability of the above;
refrain from competitive devaluations.

Repair the financial system to restore lending by:

establishing a new Financial Stability Board (FSB) with a strengthened mandate including all G20 countries, Financial Stability Forum (FSF) members, Spain, and the European Commission;
ensuring that the FSB collaborates with the IMF to provide early warning of macroeconomic and financial risks and the actions needed to address them;
reshaping our regulatory systems so that our authorities are able to identify and take account of macro-prudential risks;
extending regulation and oversight to all systemically important financial institutions, instruments and markets, including systemically important hedge funds;
endorsing and implementing the FSF’s tough new principles on pay and compensation and to support sustainable compensation schemes;
taking action, once recovery is assured, to improve the quality, quantity, and international consistency of capital in the banking system so that regulation prevents excessive leverage and require buffers of resources to be built up in good times;
ending the era of banking secrecy by taking action against non-cooperative jurisdictions (on OECD black list), including tax havens to protect our public finances and financial systems;
calling on the accounting standard setters to work urgently with supervisors and regulators to improve standards on valuation and provisioning and achieve a single set of high-quality global accounting standards; and
extending regulatory oversight and registration to Credit Rating Agencies to ensure they meet the international code of good practice, particularly to prevent unacceptable conflicts of interest.

Strengthen financial regulation to rebuild trust by:

providing up to $750bn of new funds to IMF's that is to provide it via Flexible Credit Line and reformed lending and conditionality framework;
completing the next review of IMF voting quotas by January 2011 and ensure open, meritocratic selection of leadership for IMF and the World Bank
deliberating on a new global consensus desirable on the key values and principles that will promote sustainable economic activity.

Promote global trade and investment and reject protectionism by:

refraining from measures that in their consequences reduce trade and investment flows (even though they may be accoptable under the WTO rules);
supporting trade financing with to $250 bn channeled trhough export credit agencies and multilateral development banks; and
remaining commited to Doha Round of WTO negotiations.

Build an inclusive, fair, green, and sustainable recovery by:

limit the impact of the crisis on poorest countries and people by sticking to pre-existing commitments for development and social financing and using additional $6 bn of IMF surplus and procees from gold sales to this end over next 2 to 3 years;
channel the stimulus funding towards sustainable green projects as much as possible.

What is in it for EU10?

The EU10 development models are crucially depend on their connections to global economy via open trade and capital flows. Commitment to preserve the former and provide better institutional underpinnings for the latter must be welcome in EU10 capitals. EU10 economies are bound to benefit from increased demand for their exports that stimully is likely to deliver, providing that thier trading partners do not impose any "buy American" or "build in France" type of restrictions. This may be especially relevant to stimully focused on European car demand.
Given that Hungary, Latvia and Romania depend for elementary macroeconomic stability on IMF lending, beefed up IMF is a good news. It is likely that more countries will have to reach for a stand-by agreements. If they can do so under more creative and flexible conditions, then reforms of IMF practices are welcome.
None of the EU10 economies is a member of G20 (although Czech Prime Minister was present in Londan as he holds the rotating EU presidency now). EU10 have limited role in global affairs and will have to adjust to whatever new regulatory regime evolves. However, better regulation will definitely reduce the uncertainty stemming from gaping holes in the EU and global banking regulation that keeps host-country supervisors on the sidelines. In case of failures of foreign banks dominating EU10 financial sectors, the host country regulators, central banks and governments can only hope that their home-country counterparts, will succeed in restructuring and limit the sillover-effects on EU10 economies. Improvement of the international regulatory regime that would strenghten involvement of host-country authorities and define credible ex ante rules for burden sharing is better than current vagueness and uncertainty.

Restated commitment of foreign bankers (to Romania)

2009-04-02T08:47:00.002+02:00

Financial Sector Coordination Meeting on Romania

Held at the Joint Vienna Institute on March 26, 2009, Vienna

Concluding Statement by Participating Banks

We, the parent institutions of the nine largest foreign-owned banks incorporated in Romania, with a market share of 70 percent of assets, met in Vienna, Austria, on March 26, 2009, at the invitation of the Joint Vienna Institute (JVI). The meeting took place under the chairmanship of the International Monetary Fund (IMF), with the participation of the European Commission (EC), the World Bank Group, the EBRD, the EIB, the National Bank of Romania (NBR), the home country banking supervisors and ministries of finance (Austria, France, Greece and Italy), and in the presence of the European Central Bank.

We agreed on the following considerations and conclusions:

1. We accept with satisfaction the shared analysis of the NBR, the IMF Romania team and the EC that all banks in Romania are currently in good financial condition, and that the parent banks of the foreign-owned Romanian banks have so far behaved responsibly, providing their Romanian affiliates with capital, funding, managerial and other types of expertise as the need arose.

2. The IMF, the EC and the World Bank are in the process of finalizing a balance of payments support package for Romania. We welcome this important development that will ensure the consolidation of macro-economic and financial stability in Romania.

3. We are aware that the success of the macroeconomic program, as well as medium term balance of payments sustainability in Romania will also be favorably enhanced by the continued involvement of the foreign-owned banks.

4. We entered the Romanian market as strategic investors and key contributors to its transition toward an open, market-based economy, based on our assessment of and continued confidence in the country’s long-term growth prospects. We have made substantial investments in Romania over a number of years, and we remain committed to doing business in the country.

5. We are aware that it is in our collective interest and in the interest of Romania for all of us to subscribe to coordinated commitments to maintain our overall exposure to Romania,

6. We also acknowledge that our subsidiaries in Romania will have to adjust to the current challenging economic environment. A need for additional capital cannot be excluded, and will be provided as necessary.

7. We have taken note of the agreement reached between the IMF and the NBR to run stress-tests based on established IMF methodology to estimate the potential losses that the Romanian banks might face under diverse scenarios during the period of the IMF/EU program. We support this exercise and agree to support our Romanian subsidiaries in order to: (i) confirm that these affiliates’ current good financial standing will be preserved throughout the period of market turbulences and economic slowdown; (ii) demonstrate our long-term commitment to the development of the Romanian economy; and (iii) signal our willingness to contribute to the efforts of the international community to put in place a comprehensive and well-coordinated response to the crisis.

8. We are therefore prepared to make these commitments, within the framework of the multilateral support programs, on a bilateral basis with the BNR, and with the involvement of our home country supervisory authorities, according to European and the respective national regulatory frameworks.

Erste Bank

Raiffeisen International

Eurobank EFG

National Bank of Greece

Unicredit

Societé Generale

Alpha Bank

Volksbank

Piraeus Bank

Capital controls within EU? Is that possible

2009-02-23T10:55:00.000+01:00

Willem Buiter puts another 'impossibility' on the table by predicting that at least one of the EU10 countries will introduce capital controls. In principle, this should be legally impossible as it runs into the face of EC Treaties, IMF articles, WTO rules and OECD agreements etc. On the other hand, all of these texts include clause about 'prudential opt-outs' and 'exceptional circumstances' that a desperate EU10 government could invoke to stop capital outflow or to defend itself against speculative attack.

As the financial crisis successively spills into the real economy and into political crisis, there will be no shortage of desperate governments. They may resort to some last ditch populism to prevent faith of the Latvian (and Icelandic) governments that already fell apart.

However, even if legal window is found and political will is scrambled, can one introduce effective capital controls in the EU?

There has been an attempt to do so, which Buiter misses. As the Bulgarian economy was overheating in the last two years, IMF suggested to curtail credit expansion (which was entirelly financed from abroad). They manage to reduce the growth of bank lending, but not the credit expansion. The flow has just shifted from the banking channels to other channels, including cross-border lending.

Although Bulgarians were trying to keep the money out of the country, whereas capital controls would aim to keep them in, the point is that finding efective policy instruments to stop the flow within EU may be difficult.

Buitler may still be right about the non-EU countries, which at least have officers on the borders who can check whether truckers switch to smuggling euros if their flow over the optical wires is somehow curtailed. In any case, I would not take his provocation lightly; few days back he suggested another impossibile scenario - nationalization of banks - and it took about a week to get from the fringe to the mainstream of policy discourse on the financial crisis. Impossible is increasingly possible these days.

IMF and Latvia, round 2

2009-02-23T10:34:00.000+01:00

Latvia's Government Resigns Amid Economic Crisis: IMF Deal In Doubt?
Print

* Latvia’s four-party coalition government, facing the steepest economic decline in the EU, double-digit contraction in 2009 and plunging public opinion ratings, resigned after two parties called for Prime Minister Ivars Godmanis to step down. President Valdis Zatlers said he had accepted the resignation and would start talks with all parties on a new government (See related spotlight issue: Latvia: Hard Landing In Effect, Can It Meet Conditions Of Its IMF Rescue Package?)
* Christensen of Danske: There will only be one issue at stake and that will be the austerity measures and the IMF deal. It is possible that means some parties may look to move away from the IMF deal, which would be very bad news for the Latvian economy
* In Jan, Latvia’s president threatened to call early elections after hundreds of demonstrators clashed with police during the anti-government protest organized by opposition parties and trade unions. Discontent has been brewing since the country slid into recession and the government had to seek a 7.5b euro ($10b) rescue from the IMF and EU
* An IMF-backed bailout was conditional on wide-ranging and deeply unpopular expenditure cuts: public-sector wages were being cut by 15% and the main VAT rate was increased to 21% (Danske). The finance ministry has forecast a drop in the economy this year of 12%, meaning further budget cuts are likely (Reuters)
* Vukotic: Many European governments are between a rock and a hard place. Deeply unpopular austerity measures aimed to battle the crisis fan social unrest and the political parties most likely to benefit are those who run on populist economic platforms
* EIU: Unrest was partly prompted by a painful economic downturn, but also reflects the long-standing unpopularity of the government as a result of corruption scandals
* Alvarez-Rivera: There is widespread discontent with the political establishment. Recent surveys indicate trust in government has fallen to its lowest levels since 1996 but only two opposition parties - the pro-Russian Harmony Center and the populist New Era Party - stand above the 5% threshold required to secure parliamentary representation
* In 2006, GDP expanded 12.2%, the highest rate in the EU. The economy contracted by 10.5% yoy in Q4 of 2008. According to European Commision (EC), unemployment is set to rise to 10.4% in 2009, from 6.5% in 2008
* The Latvian government was the second European government to succumb to the economic crisis after Iceland

IMF and Hungary, round 1

2009-02-23T10:33:00.000+01:00

IMF Announces Staff-Level Agreement with Hungary
on First Review of Stand-By Arrangement
Press Release No. 09/36
February 16, 2009

An International Monetary Fund (IMF) mission issued the following statement in Budapest today at the end of the first review under Hungary's Stand-By Arrangement with the IMF:

"An IMF mission, led by Mr. James Morsink, held discussions with the Hungarian authorities during February 4-16, 2009 and reached a staff-level agreement with the authorities on a package of policies that aims at completing the first review under the Stand-By Arrangement. The mission worked in close cooperation with a parallel mission from the European Commission carried out in the context of the European Union balance of payments assistance.

"In the weeks ahead, IMF staff and the authorities will work together to finalize a Letter of Intent, with a view to allowing the IMF Executive Board to consider the completion of the first review under the arrangement in late March. The completion of this review will enable Hungary to draw an amount equivalent to SDR 2.1 billion (about €2.5 billion).

"The Hungarian authorities have implemented the policies described in their previous Letter of Intent of November 2008. The quantitative performance criteria and indicative target for December 2008 were all met. Inflation was broadly as envisaged under the program. The structural performance criterion and benchmarks were also all met.

"Looking forward, the key objectives of the program remain to improve fiscal sustainability and preserve the stability of the financial sector. The worsening global environment implies a downward revision of Hungary's macroeconomic outlook and therefore the need for additional policy measures. Important measures in the fiscal area will reduce the government's immediate financing needs relative to 2008 and contribute to restoring debt sustainability over the medium term. In the financial sector, the core measures aim to maintain ample liquidity and strong levels of capital in the banking system.

"The continued success of the policy package will be a shared responsibility between all stakeholders in the country and the international community. The IMF, in close coordination with the European Union and the World Bank, will continue assisting the Hungarian authorities on how to adapt to the current global financial turmoil and to catalyze financing as needed."

Lucid summary on the future course of financial regulation

2008-12-03T17:06:00.002+01:00

The debate about new regulatory regime of the new 'innovative' financial products, many of which turned 'toxic' over th elast year, is relevant primarily to global financial centres. In this regard, the EU10 markets enjoy the 'advantage of backwardness' as bank exposure to complex securities and derivatives seem to be limited. On the other hand, new regulations in the US and UK, will sooner or later proliferate to the list of international financial standards (such as the one maintained by the Financial Stability Forum) and then to EU rules and thus to EU10 legal codes.

The testimony of the Adrew Lo to the US congress, provides rather sober and specific proposals for what may come. It is also one of the few public policy proposals that explicitly builds on behavioral finance and argues for construction of brand new institutions (such as risk focused accounting). He argues that the following seven themes are the key:

Crises are to stay, but transparency may limit impact: Financial crises may be an unavoidable aspect of modern capitalism, a consequence of the interactions between hardwired human behavior and the unfettered ability to innovate, compete, and evolve. But even if crises cannot be avoided, their disruptive effects can be reduced significantly by ensuring that the appropriate parties are bearing the appropriate risks, and this is best achieved through greater transparency, particularly in the so-called “shadow banking system”[i.e. hedge funds]. Government can play a central role in providing such transparency.
Define and measure systemic risk: Before we can hope to manage the risks of financial crises effectively, we must be able to define and measure those risks explicitly. Therefore, the first order of business for designing new regulations is to develop a formal definition of systemic risk and to construct specific measures that are sufficiently practical and encompassing to be used by policymakers and the public. Such measures may require hedge funds and other parts of the shadow banking system to provide more transparency on a confidential basis to regulators, e.g., information regarding their assets under management, leverage, liquidity, counterparties, and holdings.
Rutine investigation of collapses and learning: The most pressing regulatory change with respect to the financial system is to provide the public with information regarding those institutions that have “blown up”, i.e., failed in one sense or another. This could be accomplished by establishing an independent investigatory agency or department patterned after the National Transportation Safety Board, e.g., a “Capital Markets Safety Board”, in which a dedicated and experienced team of forensic accountants, lawyers, and financial engineers sift through the wreckage of every failed financial institution and produces a publicly available report documenting the details of each failure and providing recommendations for avoiding such fates in the future.
Good comminication with public durign crisis: To the average American, the current financial crisis is a mystery, and concepts like subprime mortgages, CDO’s, CDS’s, and the “seizing up” of credit markets only creates more confusion and fear. A critical part of any crisis management protocol is to establish clear and regular lines of communication with the public, and a dedicated inter-agency team of public relations professionals should be formed for this express purpose, possibly within the Capital Markets Safety Board.
Construct risk accounting: Current GAAP accounting methods are backward-looking by definition and not ideally suited for providing risk transparency, yet accounting measures are the primary inputs to corporate decisions and regulatory requirements. A new branch of accounting—“risk accounting”—must be developed and widely implemented before we can truly measure and manage systemic risk on a global scale.
Create capacity to handle financial complexity by paying PhDs: All technology-focused industries run the risk of technological innovations temporarily exceeding our ability to use those technologies wisely. In the same way that government grants currently support the majority of Ph.D. programs in science and engineering, new funding should be allocated to major universities to greatly expand degree programs in financial technology.
Ratcheting standardization: The complexity of financial markets is straining the capacity of regulators to keep up with its innovations, many of which were not contemplated when the existing regulatory bodies were first formed. New regulations should be adaptive and focused on financial functions rather than institutions, making them more flexible and dynamic. An example of an adaptive regulation is a requirement to standardize an OTC contract and create an organized exchange for it whenever its size—as measured by open interest, trading volume, or notional exposure—exceeds a certain threshold.

Financial crisis foretold

2008-12-01T12:33:00.001+01:00

As the financial crisis spread through the world, so does the disbelief that no one was able to predict what is to come. The banks, banking regulators, governments and international organizations, have armies of analysts and consultants, but they all seem to be surprised. This is however only partially the case.

It is true that no one at the top table of global finance - the FED, the G8, the IMF - stood up and told the world that the period of easy money is unsustainable and unless we take action to constrain it, we would hit the wall. However, many of the analysts buried deep in the hierarchies of these organizations indicated the problem. This is a quote from the 2005 speech of the IMF's Deputy Managing Director about financial sectors in EU15:

A first issue is the increasing exposure of domestic banking systems to economic cycles and developments in other countries¸ as banks extend their operations outside their home bases. In some cases, stress tests conducted during the FSAPs found that depreciation of the dollar combined with a global slowdown could be a source of significant risk to the loan portfolios; in other cases, growing exposure to transition economies in central and eastern European countries, while important for boosting profitability, was identified as a potential source of risk.

A second risk factor is the sizeable exposure of banking systems to what appear to be substantially over-valued property markets in several countries. This point has been flagged by the IMF in its regular analyses of global economic developments in recent years.

And about EU10:

... various FSAPs pointed to a number of risks, including those stemming from rapid credit growth in new and potentially riskier sectors. In nearly all the CEE countries, credit risk in loan portfolios, including that arising from exchange rate fluctuations, remains the main systemic vulnerability, although sensitivity analysis suggests, in many cases, considerable banking system resilience to a deterioration in credit quality. Another risk factor is that growing banking competition in CEE countries, and the ensuing pressure on profit margins, may encourage some banks to venture into more risky lending in order to protect returns.

In retrospect it clearly may be more the problem of bosses of these analysts who failed to pick up the key line in the cacophony of economic debates and repeat it bluntly at the top table. Especially, to Americans and Chinese ....

... who did not really want to hear this message derived from the Financial Sector Assessment Program of the IMF and World Bank that has been finished over the last 9 years for 140 countries (out of 185 members of WB/IMF). The program is non-binding and voluntary so only countries who apply are assessed. There are two important members who never applied - USA and China.

So states have no power vis-a-vis efficient financial markets?

2008-12-01T12:00:00.001+01:00

James Surowiecki of the Wisdom of the crowds fame, pointed out in his New Yorker blog:

When news broke that Timothy Geithner was Barack Obama’s pick for Secretary of the Treasury, the stock market jumped more than six per cent in the space of an hour. Obviously, this was a good thing, but there was also something weird about the spectacle of the Street’s once fearless free marketeers exulting over a government appointment, as if they were nomenklatura members cheering a new Politburo chief. It showed just how central a few government officials have become to the well-being not just of the markets but of the economy as a whole. For better or worse, we now live in a world in which the Treasury Secretary controls hundreds of billions of dollars in spending and shapes the fate of some of the nation’s biggest companies. That’s quite a job to ask someone to do.

Indeed, the "masters of the universe" start to cling to the nanny state as overconfident adolescents to their mother after they smashed their noses on reality. Despite all the proclamations that states do not have powers to regulate global financial markets, this is a refreshing return to normality. Financial markets as as embedded in the political communities (states) as most adolescents in their families.

Robert Skidelsky, while examining the intellectual foundations of the finance adolescent (here and here), takes the disembedding idea a notch further. It is not the problem of political dissembedding, but moral one. He claims that

The key theoretical point in the transition to a debt-fueled economy was the redefinition of uncertainty as risk. This was the main achievement of mathematical economics. Whereas guarding against uncertainty had traditionally been a moral issue, hedging against risk is a purely technical question.

Well it is easy to play schadenfreude on the Wall Street bankers, but the more I read about the financial crisis, the deeper it seems to go. It is not just regulatory failure compounded by the macro profligacy, which would be the issues of wrong state policies and institutions. The underlying intellectual models - such as efficient market hypothesis and a bundle of formalized mathematical models that build on it - seem to get it very wrong. May be I just read the wrong books like Black Swan and Engine, not a camera.

Hungarian promises to IMF

2008-11-17T12:14:00.001+01:00

Hungary had signed a Stand-by agreement with IMF on November 4, 2008. Apart the standard clauses on the fiscal and monetary policy, it includes a section on the financial sector policies. Although, these commitments are made under pressure to fence off the impact of the global financial crisis, they may foreshadow future changes of the EU10 banking regulatory regimes.

The reason why Hungary is threatened by the financial crisis more than her Visegrad neighbors is fiscal profligacy of her government. High debts and high deficits of public finance over the last few years induced the independent central banks to restrictive monetary policy. In turn, high interest rates (and rather stable exchange rate of forint) motivated households to borrow in euro, Swiss francs or even yen. This resulted in the much higher vulnerability of household balance sheets as they essentially bear unhedged exchange rate risk. Both of these risks were exacerbated by the financial crisis that triggered liquidity trap and capital outflows from emerging markets.

In this context, the Stand-by agreement reviews what by today counts as standard firefighting measures including:

IMF stand-by of up to 12.5 bn euro for the next 17 months;
ECB lending facility of up to 5 bn euro;
EBRD is also mentioned as ready to step into banks;
doubled deposit insurance from 6 to 13 million HUF, topped by blanket guarantee of all deposits;
providing a support package for systemically important banks that contains provisions for added capital and funds a guarantee fund for interbank lending (up to HUF 600 billion in total); this support could increase banks' CAR to 14 pc.

To address the foreign lending problem of households, the agreement envisages that banks and indebted families would

at the request of the debtor, allow the duration of the loan to be extended with fixed monthly installments;
debtors who deem that exchange rate fluctuations carry excessive risks will be allowed to convert their foreign currency-based loan to a forint loan, without extra charges; and
in the event that a debtor is unable to service the existing loan, the banks will be amenable to transitionally reducing the installments at the request of the debtor.

The crisis also induced the Hungarian government to submit laws to the parliament that would allow Hungarian Financial Service Authority and financial infrastructure to catch up with most of their EU10 neighbors have done few years ago.

Introducing numerically defined triggers of remedial actions and emergency powers;
improving the efficiency of the bank resolution regime to facilitate paying out quickly to depositors in case of need.
introduction of a positive credit registry for households,
modification of the Central Bank Act to allow the MNB to request individual but unidentifiable data to adequately analyze credit risk,
enhanced regulation of insurance and credit brokers and their products,
introduction of maximum loan-to-value ratio requirements for new mortgage loans, and
close monitoring of banks’ foreign exchange exposures
strengthening communication with financial authorities in home and host countries regarding risk assessments and liquidity contingency plans.

Judging what all this means for the future of banking regulation in EU10 is fraught with uncertainties. However, unless we see major moves on the EU level and providing that existing regulatory regime will only be patched not scrapped, we could observe the following:

a comfortable capital adequacy for turbulent times in emerging markets is neither 8 pc required by Basel I, nor 9 to 12 pc. observed across EU10, but more (Hungarian government on betting on 14);
reintroduction of some simple regulatory measures such as loan-to-value ratios that fell out of fashion during the good times;
to make the EU10 regulatory regime credible vis-a-vis parent banks and their home-country regulators, a rigid triggers of regulatory action may be needed;
more transparency and data sharing to monitor system level risks;
integration of regulation of banking and other financial services;
stronger regulatory cooperation on EU level.

All of this has always been on the table. However, the unpleasant experience of Hungary and also Baltic states and Romania and Bulgaria, may help to turn the proposals into action.

G20 on banking regulation and leadership responsibility of EU

2008-11-17T10:22:00.001+01:00

The G20 meeting this weekend was more important for the fact that major emerging economies were invited than for the substantive decisions. It all makes sense to get India and China at the same table with G8, but it does not make it easier for the US to swallow any kind of supranational financial regulation. I guess we need to wait for the new brand of Obama multilateralism to see any progress on this front.

The G20 statement is thick on good intentions, but thin on specific proposals:

Increased transparency of financial sector, regulation of rating agencies, avoiding pro-cyclical regulation, increased information sharing between national authorities, expanding the FSF to include emerging economies and ensuring that IMF and other multilateral institutions to have sufficient resources to support emerging economies capital needs.

It practically shift the ball to the Financial Stability Forum that should develop substantive proposals for the next meeting of G20 in April 2009.

I doubt that FSF would be able to cut through the complexity of the global financial markets and formulate the future vision of the global financial architecture that could deal with all aspects listed by G20. Actually, I believe the EU 27 should be the leader in terms of substance of the new financial regulations. If EU cannot make progress towards supranational regulatory regime, than chances for global progress are slim.
Today EU is composed of both developed (EU15 + 2) and emerging economies (EU10) and its financial sectors cover the full spectrum from cutting edge of finance in the City of London, to rather sleepy backwaters in Prague or Bratislava (today the 'advantage of backwardness' is worth billions of dollars as it means little exposure to 'innovative' financial products that proved 'toxic' so Czech and Slovaks may still hope to get through the financial crisis without involvement of state finance). At the same time, EU financial markets are highly integrated, but the regulation is still based on home-coutry supervisors and its supranational dimension did not progress beyond vague memoranda of understanding and moreorless informal consultation process.
EU is well aware of the discrepancy between the financial integration and fragemnted regulation. Few years ago it even devised so called Lamfalussy procedure to be able to catch up on the regulatory side. However, even before the financial crises the regulatory integration hit the wall. Even the idea of regulatory colleges for major internationally active banks that now seems a nobrainer proved too politically contested to be passed.
As is often the case, lack of compromise boils down to interest-group politics. The policitical cleavages among vested interests in different countries proved too numerous. Brits, like Americans on the global scale, are suspicious on the supranational regulators. French push for centralized heavy-handed approach. Germans worry about their para-statal landes banks. The EU10 countries are not quite sure whether they should try somehow to adjust their regulatory regimes to the fact that all their banks are controlled from abroad (so they just hope for the best now). Moreover, the non-euro countries are not keen on letting ECB (which usurped the bank supervision responsibilities) to supervise their banks. Moreover, the retail banks are not keen on reducing regulatory barries to competition, whereas wholesale banks support it. Moreover, parties on each side of these plentiful cleavages are shiftting all the time. No wonder EU did not make much progress.
On the other hand, time of crisis force some clarity of thinking and make clearer the relative costs and benefits of various arrangements. Some refined objections to supranational regime lose their persuasiveness as bad news keep coming. Some political compromises, such as argeements on burden-sharing of fiscal cost of banks active in many EU countries, that would be unthinkable in the normal times may be possible in extraordinary times. Economists call this benefit of crisis. If EU could seize on them, the rest of the globe would be more likely to follow.

Marek Belka and Erik Berglof: New Europe Catches Old Europe’s Cold

2008-11-12T23:10:00.002+01:00

via Project Syndicate on 11/11/08

LONDON – As governments across Western Europe began bailing out banks and their depositors, Eastern Europeans watched nervously, unsure about what the global financial storm would mean for them. Now that the storm has hit, the fragile bonds of European solidarity are being tested.Two countries – Hungary and Ukraine – have already asked for large packages of support. Several more could do so over the next month if frozen credit markets do not thaw. If the situation continues until the end of the year, which cannot be ruled out, many more countries could experience serious banking crises.Over the last two decades, Eastern Europe has undertaken wide-ranging reforms and embraced global financial integration. Foreign, mostly European, banks have entered these markets with unprecedented speed and force. These banks have increasingly reached out to more risky small- and medium-sized enterprises and helped people buy their own houses and start new businesses. But successful financial development is now coming back to haunt these countries.Until now, the countries of emerging Europe withstood the global financial squeeze remarkably well, coping with the slowdown in important export markets and increased borrowing costs. But no open economy can resist a complete shutdown of the lending markets. Perhaps they became too dependent on cheap credit, but they were not alone in this respect.Some foreign banks are now withdrawing liquid funds from subsidiaries in emerging Europe. According to the National Bank of Russia, foreign banks withdrew more than $10 billion in that country in September alone. Other central banks make similar claims. To be fair, Raiffeisen International has announced that it was supporting its Ukrainian subsidiary, Bank Aval, with an additional €180 million. Whether other parent banks active in the region stand by their subsidiaries depends on how severe the crisis in Western Europe becomes.But the Western European bailout packages could make the situation in emerging Europe worse. While most parent banks in the region are likely to benefit from these measures, this does not necessarily translate into support for their foreign subsidiaries. In fact, there is a serious risk that these bailouts will come at the expense of Eastern Europe. Several governments have declared that taxpayer money cannot go into operations abroad.Governments in emerging Europe should, of course, play their part in stabilizing their financial systems. But at this point there are severe limits to what they can do. Most do not have the financial clout to counter the extraordinary pressures from financial markets. An offer by Hungary’s government to extend a general guarantee of deposits or to ensure liquidity in interbank markets has limited credibility.To survive this crisis, emerging Europe needs support from outside. First and foremost, West European leaders must ensure that the crisis is resolved at the core, and many observers doubt that they have done enough. Second, they must prevent the crisis measures already taken from discriminating against subsidiaries in Central and Eastern Europe, independently of whether they are within or outside the European Union. Third, they must combine forces, as in Hungary, with international financial institutions in supporting these economies.Georgia’s experiences following its recent war with Russia offer a possible model. The International Monetary Fund provided an emergency credit line to support the currency, the World Bank coordinated the relief effort (much of it financed by the United States and the EU), and the European Bank for Reconstruction and Development used its knowledge and resources to lead the effort to save the financial system. The Georgia package is not a done deal, and circumstances elsewhere are different, but it shows that standard instruments can go a long way.Yet more resources and new instruments will be needed. The case of Hungary shows that the EU can tweak an existing instrument – balance-of-payment support – and use it creatively. For non-EU countries, like Turkey and Ukraine, innovative ideas are also urgently needed.There should be no doubt about what is at stake. It is has been little noticed, but in the last few years, Eastern Europe, including Russia, surpassed the US and the United Kingdom as the euro zone’s most important export markets. Many of these markets now face slowdown or even negative growth. Moreover, Western European companies have invested on a previously unimaginable scale. There is a serious risk that, if the crisis becomes even worse, East European governments will see no alternative but to nationalize some institutions, particularly some of the foreign-controlled banks.But, even more importantly, decades of financial development and broad economic reforms could unravel. As in Western Europe and the US, governments will again play a larger role in the economy, but state involvement has different connotations in these former socialist economies, particularly as they now face a backlash against financial development and against reformers.As if this was not enough, Western governments and businesses should ponder what kind of offers may come from Russian sources, private or public, for distressed banks and companies. No doubt with strings attached.

Rating downgrades of CEE countries

2008-11-12T22:37:00.001+01:00

S&P and Fitch responded to mounting risks from global credit crunch by
downgrading or revising credit rating outlook to negative for Baltic
states, the Balkans, and Hungary in October and November 2008. [from
RGE monitor]

Back to the 1990s: bank nationalization in Latvia

2008-11-12T10:12:00.000+01:00

The queues of depositors and overnight government sessions discussing state takeovers of private banks are back. In Latvia the answer was yes, when the state took over the second-largest bank - Parex Banka - on November 10, 2008. This bought back memories of collapse of Banka Baltija in 1995, which was one of the few cases of large bank collapses in EU10 that were not fully compensated to small depositors.

The choices faced by the Latvians were the usual dilemma with the too-big-to-fail banks:

"This was the choice: to allow the bank to go bankrupt or to secure the financial system," Slakteris [Latvian minister of finance] said, further explaining the decision.

The government estimated that compensating the Parex depositors would cost about 1 billion euro and reckoned that taking the bank over, stabilizing it and reselling in less turbulent times, may be a better option. The government bought out the largest shareholders of Parex and got the 51 percent stake for just under 3 euros.

In the context of EU10 banking markets, Parex was an unusual case. It was controlled by local interests, with its chairman being the largest shareholder. Most of banks with such an ownership structure in other EU10 countries went under much earlier or in a few happier cases were taken over. Today major banks in most EU10 countries are part of some multinational financial groups.

There are some other exceptions such as Hungarian OTP, which is also controlled by its chairman and dispersed shareholders. The OTP recently faced a speculative trading on the Budapest stock exchange, which may suggest that banks that are not controlled by a dominant foreign owner may have one more reason to worry throughout the current uncertainty on the markets.

What this story tells us:

So far the reliance on the foreign bank ownership pays off for EU10 countries. Being part of the transnational banking group is clearly an advantage for EU10 banks. It provides some guarantee that parent banks would step in in case of losses (for example, Swedish banks that dominate banking sectors in the Baltic 3, can write-off 10% of all their assets in these countries, without their prudential indicators reaching minimal levels).
There is an 'advantage of backwardness' for EU10 banks and banking sectors. They did not get too involved with toxic assets from US, because this kind of proprietary trading is done on the financial group level in one of the European financial centers. Given that EU10 banks are locally incorporated (i.e. not mere branches under the EU single-passport rules), they are protected from toxic stuff by the limited liability of their parent.
It also tells about the phenomenal growth of the Baltic economies over the last few years. Over the last three years, Latvian economy grew by over 10 percent annually. At the same time, the credit to domestic private sector grew from 50.8 to 93.7 pc of the (fast growing) GDP. This indicates high credit intensity of growth and most likely a pile of non-performing assets as the economy gets to recession.

What may come from the G20 meeting on financial reform

2008-11-10T09:16:00.001+01:00

In a week the G20 meets in Washington to agree on the reform of global finance. It seems that no revolutionary idea is in the pipeline:

... leaders said they want an early warning system to watch for imbalances in financial markets, make the International Monetary Fund the world's financial watchdog, improve supervision of financial players and close loopholes that let some institutions avoid regulation. (see here)

The biggest news is that US is ready to go along with EU and introduce new regulations. However, they should start at home and clear the mess of the 150+ bodies that regulate different segments of US financial markets on federal and state level. If EU and other international partners could negotiate with just one insurance regulator rather than 50, reaching some conclusion might be easier. I suppose the days when [US] economists pride themselves that "regulatory competition" among 50 state jurisdiction is great for 'innovation' on financial markets are over.

The BRIC seem to be pushing for greater representation in IMF and World Bank, which is justified, but this issue should not crowd out the real work on global financial architecture.

Government pressure on banks in China

2008-11-07T12:50:00.003+01:00

I have just sent the final version of my paper on Banking reforms in China (see pre-rint version here).

The last senstense of the abstract reads:Selectiveness of institutional reform means that the largest banks remain under state control and can be used as means of development policy for the better or the worse.

It seems that this claim will be tested soon. Today Bloomberg reports:

China's largest banks, with 4 trillion yuan ($586 billion) of cash, are resisting government efforts to boost lending to 42 million small and medium-size companies that drove the economic boom of the past decade. On Nov. 2, the central bank scrapped curbs on loans after three interest rate cuts in seven weeks failed to revive economic growth that has sagged to its slowest in five years.

It will be interesting to see whether the Chinese goverment will puch its will through the indirect regulatory tools and agreements that respect proclaimed commercial autonomy of banks or whether will resort to traditional force of pushing its will via party committees and personel policies that they control.

IMF, EU, and World Bank Line Up $25 Billion for Hungary

2008-11-03T09:50:00.000+01:00

* Hungary has comprehensive policy package to restore investor confidence
* Program's core measures aim to strengthen financial sector
* Fiscal steps to reduce government financing needs, ensure debt sustainability

The IMF, the European Union (EU), and the World Bank announced a joint financing package for Hungary totaling $25.1 billion to bolster its economy, hit by recent financial market turbulence.

Subject to agreement by the IMF's Management and Executive Board, the IMF is ready to lend Hungary $15.7 billion (12.5 billion euro) under a 17-month Stand-By Arrangement. The proposed package could be reviewed by the Board under the Fund's emergency procedures in early November, the IMF said in a press statement.

The EU stands ready to provide a loan of €6.5 billion ($8.1 billion), and the World Bank has agreed to provide €1.0 billion ($1.3 billion).

Third financing package

The IMF is moving quickly to help emerging markets battered by fallout from global financial turmoil and the sharp slowdown in the economies of advanced industrialized countries. The 185-member institution has more than $200 billion of loanable funds and can draw on additional resources through two standing borrowing arrangements with groups of IMF member countries.

The planned financing package for Hungary follows within days earlier announcements of tentative loan agreements with both Iceland and Ukraine. The IMF is also in discussions with several other countries about possible new lending programs.

Restoring confidence in Hungary

The IMF said in the statement that the Hungarian authorities have developed a comprehensive policy package designed to restore investor confidence and alleviate the stress experienced in recent weeks in the Hungarian financial markets. It will bolster the economy's near-term stability and improve its long-term growth potential, the IMF said.

Core measures under the program are designed to improve fiscal sustainability and strengthen the financial sector. Specifically, the package includes measures to secure adequate domestic and foreign currency liquidity, as well as strong levels of capital for the banking system.

Important measures in the fiscal area will reduce government financing needs and ensure longer term debt sustainability. 'These strong policies justify the exceptional level of access to Fund resources—equivalent to around 1,020 percent of Hungary's quota in the IMF—and deserve the support of the international community,' said IMF Managing Director Dominique Strauss-Kahn.

The success of the policy package will be a shared responsibility between all stakeholders in the country and the international community. The IMF has worked in close coordination with the European Union, the European Presidency, and the World Bank on the issue. 'We will continue assisting the Hungarian authorities on how to adapt to the current global financial turmoil and to catalyze financing as needed,' Strauss-Kahn added."

If you have short post delete all this. If long then write the summary for the front page above the code in <>. Do not delete the code. (If you do not see the code, click "Edit Html" tab.)

Copy the summary under the code in <> and write the rest of the text. Make sure that the other bit of code stays at the end.

'Panic' Strikes East Europe Borrowers as Banks Cut Franc Loans

2008-11-02T20:08:00.000+01:00

By Ben Holland, Laura Cochrane and Balazs Penz
More Photos/Details

Oct. 31 (Bloomberg) -- Imre Apostagi says the hospital upgrade he's overseeing has stalled because his employer in Budapest can't get a foreign-currency loan.

The company borrows in foreign currencies to avoid domestic interest rates as much as double those linked to dollars, euros and Swiss francs. Now banks are curtailing the loans as investors pull money out of eastern Europe's developing markets and local currencies plunge.

``There's no money out there,'' said Apostagi, a project manager who asked that the medical-equipment seller he works for not be identified to avoid alarming international backers. ``We won't collapse, but everything's slowing to a crawl. The whole world is scared and everyone's going a bit mad.''

Foreign-denominated loans helped fuel eastern European economies including Poland, Romania and Ukraine, funding home purchases and entrepreneurship after the region emerged from communism. The elimination of such lending is magnifying the global credit crunch and threatening to stall the expansion of some of Europe's fastest-growing economies.

``What has been a factor of strength in recent years has now become a social weakness,'' said Tom Fallon, emerging-markets head in Paris at La Francaise des Placements, which manages $11 billion.

Plunging Currencies

Since the end of August, the forint has fallen 16 percent against the Swiss franc, the currency of choice for Hungarian homebuyers, and more than 8 percent versus the euro. Foreign- currency loans make up 62 percent of all household debt in the country, up from 33 percent three years ago.

Romania's leu dropped more than 14 percent against the dollar and 3.2 percent against the euro. Poland's zloty declined more than 17 percent against the dollar and 6.8 percent versus the euro, and Ukraine's hryvnia plunged 22 percent to the dollar and 11.5 percent to the euro.

That's even after a boost this week from an International Monetary Fund emergency loan program for emerging markets and the U.S. Federal Reserve's decision to pump as much as $120 billion into Brazil, Mexico, South Korea and Singapore. The Fed said yesterday that it aims to ``mitigate the spread of difficulties in obtaining U.S. dollar funding.''

Plunging domestic currencies mean higher monthly payments for businesses and households repaying foreign-denominated loans, forcing them to scale back spending.

In Kiev, Ukraine, Yuriy Voloshyn, who works at a real-estate company, says he's forgoing a new television because of his dollar-based mortgage. His monthly payments have risen by 18 percent, or 1,000 hryvnias ($167), since he took out the loan seven months ago.

No More Dreaming

``I only have money to pay for food and my monthly fee to the bank,'' Voloshyn, 25, said. ``I can't even dream about anything else.''

Rafal Mrowka, a driver from Ostrow Wielkopolski in western Poland, says he became addicted to checking foreign-currency rates as monthly installments on his Swiss-franc mortgage jumped 25 percent.

``I've even stopped getting nervous, now I can only laugh,'' the 32-year-old, first-time property owner said.

The bulk of eastern Europe's credit boom was denominated in foreign currencies because they provided for cheaper financing.

Before the current financial turmoil, Romanian banks typically charged 7 percent interest on a euro loan, compared with about 9.5 percent for those in leu. Romanians had about $36 billion of foreign-currency loans at the end of September, almost triple the figure two years earlier.

In Hungary, rates on Swiss franc loans were about half the forint rates. Consumers borrowed five times as much in foreign currencies as in forint in the three months through June.

`Serious Problems'

Now banks including Munich-based Bayerische Landesbank and Austria's Raiffeisen International Bank Holding AG are curbing foreign-currency loans in Hungary. In Poland, where 80 percent of mortgages are denominated in Swiss francs, Bank Millennium SA, Getin Bank SA and PKO Bank Polski SA have either boosted fees or stopped lending in the currency.

The extra burden on borrowers is making a bad economic outlook worse, said Matthias Siller, who focuses on emerging markets at Baring Asset Management in London, where he manages about $4 billion.

If borrowers believe local interest rates are prohibitive and foreign currency lending dries up, it means ``a sharp deceleration in consumer spending,'' Siller said. ``That will bring serious problems for the economy.''

The east has been the fastest-growing part of Europe, with Romania's economy expanding 9.3 percent in the year through June, Ukraine 6.5 percent and Poland 5.8 percent. The combined economy of the countries sharing the euro grew 1.4 percent in the period.

IMF Help

Governments are seeking to ease the pain as recession concerns sweep across eastern Europe's emerging markets.

Ukraine, facing financial meltdown as the hryvnia drops and prices for exports such as steel tumble, on Oct. 26 agreed to a $16.5 billion loan from the IMF.

Hungary on Oct. 28 secured $26 billion in loans from the IMF, the EU and the World Bank. The government forecast a 1 percent economic contraction next year, the first since 1993.

The Hungarian central bank raised its benchmark interest rate by 3 percentage points to 11.5 percent on Oct. 22 to defend the forint.

The same day, Prime Minister Ferenc Gyurcsany said the government was seeking an accord with banks to ``prevent the burdens of debtors from reaching the sky.'' It's considering granting borrowers extended payment periods or the ability to convert foreign-exchange debts into forint.

Panicked Customers

``Panicked customers are calling to say they're afraid the interest on their mortgages will go up or that they won't be able to secure mortgages,'' said Nikolett Gurubi, director of lending at Otthon Centrum Belvaros, the downtown Budapest branch of a real estate agency.

Project manager Apostagi, 58, said he hopes the crisis will be over in a few months, blaming U.S. banks for creating such distrust between lenders. For now, ``it looks like our signed contracts were for naught,'' he said.

Romanian central bank Governor Mugur Isarescu sounded the alarm in June, saying the growth of foreign-currency loans was ``excessively high and risky,'' especially because Romanians with their communist past aren't used to the discipline of debt.

``It's not that we're bad,'' Isarescu said. ``It's that, culturally, we need to prepare for the moment of repayment.''

At the other end of the spectrum, Turkish consumers have proved more cautious after living through their own currency crises in 2001 and 1994. The government, the IMF's biggest customer in recent years, is resisting new loans from the fund, arguing that its economy can weather the credit crunch and a 22 percent slump in the lira since the start of September.

`Cheaper, Riskier'

Turkish savings in foreign currencies exceeded loans by about 30 percent as of the end of 2007, according to a January Fitch report. In Poland foreign exchange loans were double deposits, and in Hungary they were triple.

Mert Sevinc borrowed the equivalent of $100,000 in Turkish liras to buy an Istanbul apartment in 2006, paying an annual rate of 13.5 percent. The marketing consultant didn't even look at the foreign exchange loans at less than half that price.

``Of course it would have been cheaper to borrow in dollars or euros, but it's a fairly basic principle of finance: Things that are cheaper are riskier,'' he said.

That reasoning may soon be part of the eastern European psyche too.

``We've been observing a return to a good old banking rule to lend in a currency in which people earn,'' said Jan Krzysztof Bielecki, chief executive officer of Poland's biggest lender, Bank Pekao SA. It stopped non-zloty lending in 2003. ``Earlier, banks competed on the Swiss franc market watching only sales levels and not looking at keeping an acceptable risk level.''

The problem is a ``good lesson to all of us,'' Polish President Lech Kaczynski said at an Oct. 24 press conference in Warsaw, where he urged Poles to stick to zloty lending.

To contact the reporter on this story: Ben Holland in Istanbul at bholland1@bloomberg.net. Laura Cochrane in London at lcochrane3@bloomberg.net; Balazs Penz in Budapest at bpenz@bloomberg.net."

Big Bad Banks are Back

2008-11-02T19:03:00.000+01:00

Big Bad Banks are Back
Victor Shih | Oct 28, 2008

I just saw a pretty alarming figure today from the 21st Century Economic Herald. I attach it here for readers' reference, but unfortunately, it is in Chinese. Let me explain though. The rows basically show changes in non-performing loans in 100m RMB unit and in percentage for state banks, joint-stock banks, city commercial banks, agricultural commercial banks (RCCs), and foreign banks respectively. The columns are 1Q08, 2Q08, 3Q08, and change between 1/1/08 and 3Q. Although overall, banks were able to achieve 'double declines,' an important CBRC target that seeks to decrease both NPL amount and NPL ratio. However, as we can see on the second row with figures, much of the work is done by the joint stock banks. For the state banks (ICBC, ABC, BOC, and CCB) shown on the first row with figures, 2Q and 3Q NPL amount actually increased by 10 billion and 14 billion RMB respectively. As a percentage, that is a small increase, but it is the first such increase in a few years. Overall, state banks, which control like 60% of the market, saw an increase of 2.4 billion in NPLs. Granted, that is a tiny amount. However, please bear in mind that the state banks are in the mean time writing off loans every quarter (if readers know by how much, please share, but my guess is 2-300b RMB a quarter). Also, the loans that show up as NPLs now were already in trouble at the beginning of the year. I think in most places, real estate developers didn't get in serious trouble until June or so. Thus, as we move toward first and second quarter next year, the loans that are currently overdue (not non performing) will become NPLs. I think the market is reacting to this now and will continue to react as such until the true scope of the problem is known.

The up side of the story, however, is that the joint-stock banks are holding up remarkably well in the current environment. Of course, some of them, like Industrial Bank, may be in trouble in the future. However, thus far, they have managed to hold down NPL ratios. The real estate problem will hit them hard, but perhaps better corporate governance will keep them from too much trouble. This accords with my paper from a couple years back showing joint-stock banks as the best performing banks in China. For the foreign banks, they begin with a clean balance sheet, but they are now facing the first real challenge of doing business in China. This will be a true test of whether their due diligence works in China. I suspect that there will be some nasty surprises for many."

World Bank Welcomes Hungary’s Agreement With The International Monetary Fund

2008-11-02T17:38:00.003+01:00

Sent to you by Brum via Google Reader:

World Bank Welcomes Hungary’s Agreement With The International Monetary Fund

via Czech Republic | World Bank on 10/28/08

The World Bank

Europe and Central Asia Region

Contacts:
In Washington: Kristyn Schrader, (202) 458-2736
kschrader@worldbank.org

Washington DC, October 28, 2008 - The World Bank welcomes the agreement reached between Hungary and the International Monetary Fund on a policy package to address economic and financial vulnerabilities in the wake of the global economic crisis, and is ready to provide one billion euros as part of a program supported by the European Union and International Monetary Fund.

"As part of the international effort, the World Bank stands ready to do its part to provide financing and help tackle long-term structural problems," said Shigeo Katsu, Vice President of the World Bank for Europe and Central Asia.

Orsalia Kalantzopoulos, World Bank Director for Central Europe and the Baltic Countries said, "We are working with the Hungarian authorities to see how we can best support a faster economic recovery. Proposed World Bank assistance would support the design and implementation of reforms in key areas, such as the financial sector, fiscal management, and social sector reforms. These measures would support the country's longer-term stabilization and economic restructuring."

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Global financial crisis is affecting EU10

2008-11-02T17:38:00.001+01:00

Sent to you by Brum via Google Reader:

Global financial crisis is affecting EU10

via Europe and Central Asia World Bank on 10/30/08

Sofia, October 30, 2008 — The 10 New Member States of the European Union (EU10) are affected by the ongoing global financial crisis and growth will be slower this year and next due to weak external demand and tight credit conditions, says the latest World Bank EU10 Regular Economic Report.

The Report, published three times a year to cover economic developments in the new member states of the EU, follows the news this week of an agreement reached between Hungary and the International Monetary Fund (IMF) on a policy package for Hungary to address economic and financial vulnerabilities in the wake of the global economic crisis, with the World Bank ready to provide one billion Euros as part of a program supported by the IMF and European Union.

According to the EU10 Regular Economic Report, the international financial crisis intensified since early October and resulted in an acute tightening of interbank markets, bank consolidation and takeovers in developed economies, and a sharp drop in global equity prices. These developments have been accompanied by a dramatic increase in volatility for equities, commodities, and currencies. The financial turmoil has spread quickly to reach to EU 10 countries and credit default swap spreads have widened. Also, banking system in some countries in the region has experienced a shortage of liquidity reflected in sharp increases in interbank rates.

Weak external demand and tightening of credit conditions will likely result in a decline in export and investment growth. While a further moderate slowdown appears likely in Bulgaria, the Czech Republic, Poland, and Slovenia, other countries (such as Romania and Slovakia) are likely to face a larger slowdown, but also from higher rates of economic growth. The Baltic countries and Hungary may face a more painful downturn, says the Report.

Inflation has peaked in most EU10 countries but remains elevated. Declining energy import prices since midyear and an abundant harvest make it likely that inflation will ease further, but uncertainty remains.

"Weak growth will put pressure on living standards, especially in the poorer EU10 countries," says Ivailo Izvorski, the principal author of the Report. "The importance of properly funding and improving the targeting of social protection systems in these circumstances is becoming increasingly important."

The current account deficits in Estonia and Latvia have narrowed markedly this year, but the Baltic countries, Bulgaria, and Romania still have large external shortfalls.

Commenting on the Report, World Bank Country Director Orsalia Kalantzopoulos said that "The World Bank stands ready to continue working with countries in the region to support their policies and reform programs through lending or analytical and advisory service."

The new EU10 Regular Economic Report is published three times a year. It monitors macroeconomic and reform developments in the new member states of the EU and provides an up-to-date summary of economic developments and in-depth analyses of key current economic policy issues.
_____________________________________________
*The EU10 refers to Bulgaria, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia and Slovenia

To read the report, please visit:
http://www.worldbank.org/eca/eu10rer

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Bankers fear credit crunch may have longer-term impact

2008-10-27T18:51:00.000+01:00

Bankers fear credit crunch may have longer-term impact
By: Cristina Muntean, 27. 10. 2008

Czech banks have been tightening their grip on personal and corporate lending throughout October, confronted with high nervousness on the interbanking market and conservative headquarters increasingly worried about a global recession. While for the moment such measures won’t affect local banks’ profitability, analysts say a longer-term spillover effect of the credit crunch will take a toll on the Czech economy as well.

It is an open secret in Prague that the interbanking market has been experiencing hiccups during October, if not being frozen. On Oct. 20, economic daily Hospodářské noviny quoted unnamed bankers who acknowledged the shortage of capital flow among banks that are pushing for short-term loans rather than longer-term ones. “Banks are stockpiling cash, in case something goes wrong and they run into trouble,” HN wrote. The freeze is also valid for the bond market.
Reportedly, the nervousness was triggered by the ignition of troubles of major banks in Belgium, headquarters of KBC, mother bank of one of the Czech largest first tier banks, Československá obchodní banka (ČSOB). Even if the Belgian and Dutch governments took over problematic Fortis Bank and France was also involved in safeguarding Dexia, no one seems convinced that troubles are already over. At the same time, Italy’s UniCredit, mother of the local UniCredit Bank Czech Republic, recapitalized at the beginning of October and is looking for further money raising. With the crisis so close, lack of confidence has spread in Prague as well. “There were concerns among the big banks in the Czech Republic, but their managers denied them so far,” said Milan Lavička, a bank analyst with brokerage Atlantik finanční trhy.
“The interbanking market in the Czech Republic is indeed influenced by the global credit crisis, which can be observed on the wider bid-per-ask spreads and higher spread between the [interbanking] PRIBOR rates and Czech National Bank (ČNB) repurchase agreement (REPO) rates,” said Marek Hatlapatka, head of research with brokerage Cyrrus.

“I can’t say the market is frozen; it still works, but spreads aren’t so wide. There is nervousness, but the Czech National Bank (ČNB) intervened on time to calm down the situation,” said David Navrátil, an analyst with largest Czech retail bank Česká spořitelna (ČS). “The market is working, despite certain nervousness,” he said.

A toll on results?

Analysts claim the hiccups won’t take a short-term toll on the banks’ profitability, as banks will be still enjoying the benefits of record growth in 2007. Instead, on a longer term, as the spillover effect of the global credit crunch is reaching the Czech economy, banks are expected to slow down with the economy and forget about double-digit profit growth. “Actually, banks will go back to ‘normal’—a one digit, stable growth perspective,” Navrátil forecasted.

Lavička said that the credit crunch impact on results wasn’t visible in the first half of 2008. Even if ČS decided to go for some limitations in mortgage lending that reduced its market share, second-largest retail bank Komerční banka (KB) actually increased the number of new mortgages provided. “We believe the impact will be different for each bank,” he said.

“We don’t see any real cutting in services, but just limitation of some profitable, but higher-risk products,” Navrátil said, adding that his bank announced a 43 percent increase in consumer loans in the third quarter of 2008. “There is no credit crunch here so far,” he said.

Hatlapatka agreed that Czech banks’ results probably won’t be negatively influenced to some bigger extent. The main reason is that Czech banks generally depend to a large extent on deposit financing. For example, in 2007, deposits of Czech banks covered 62 percent of total banking assets. On the other side, interbank loans and bonds covered only 18 percent of assets, he said. Compared to that, in Western Europe, banking deposits usually cover only about 40 percent of total assets, while interbank loans and bonds cover about 30-35 percent of typical retail bank assets.

There are, however, differences on the market. On the one hand, the “big three” Czech banks —ČS, KB and ČSOB—had the deposits per total asset ratio at 68 percent in 2007 and interbank loans plus bonds per total assets ratio at 9.5 percent. “This means that their results should be less sensitive to higher interbank rates than the average Czech bank and substantially less sensitive than their Western European peers,” Hatlapatka said. Other banks in the Czech Republic often do not have such a deposit base, so they are dependent on interbank or bond financing to the bigger extent.

Therefore, we should look at them if we look for a negative effect of the slowdown in the interbanking market on their 2008 results.

A matter of trust

Despite the apparent level of health, Czech banks are still sensitive to commands coming from their headquarters. Experts say that if mother companies ask for conservativeness, local banks have to adapt their policies. However, this isn’t expected to go further than that. “Local banks have their own risk models and will rather adapt to conditions from the local market than commands from headquarters,” Lavička said.

“If headquarters are conservative, there will be more conservative subsidiaries as well,” said a banker who declined to be identified. “It’s a chicken-egg problem. Bankers become more conservative, so they don’t release money in the economy because of the mood. Later, when they gain confidence, they have to lend to an already-hurt economy,” the source said. However, “[local] banks won’t sit on a pile of money if they have it and refuse to lend if they have reasons to do it.”

International economic media reported that so far, only a fourth of the problematic collateral debt obligations (CDOs) have been identified in banks’ books worldwide. As governments are pushing more liquidity in the financial systems worldwide, these remaining poisonous CDOs could diminish in importance and stop affecting the organism of their holder. Yet, the difficult track record of these financial instruments boosts the lack of confidence among banks. “It isn’t normal for a bank to lose 80 percent of its stock price in a year. Now you can buy a bank almost for nothing. If one looks at the size of falls, one can identify the exposure of a certain bank to the crisis,” the source said. “I’m afraid the worst is yet to come.”

Business as usual?

The largest Czech bank by assets, Česká spořitelna, told CBW that its conservative approach served it well, despite criticism it received in the past.

Pavla Langová, a spokeswoman with ČS said that her bank hasn’t been directly influenced by the financial crisis. “As we didn’t invest money into highly risky products, we didn’t encounter problems with liquidity, and our deposits surmount loans by far,” she said. She denied changes in terms of stopped products or services due to the crisis. “For our clients nothing has changed,” she said. However, she refused to say how much money her bank is paying now on short-term interbank loans compared to a similar period in 2007. “Those are internal data. In general, our business model hasn’t changed, and our relationship and business with other banks and clients remains unchanged,” she said.

Even if developers such as Orco Property Group or ECM Real Estate Investments have been feeling the heat as less money flew into their projects (see “Lack of finance to hit real estate sector,” CBW, Oct. 20, 2008), Langová said that the cooperation with developers and large corporations remains unchanged. “We are not entitled to provide information on deals with our clients, as these are a subject of banking confidentiality according to the law,” she said, defending the position of her bank. “We aren’t directly influenced by the crisis thanks to our cautious and long-term sustainable business policy.”

ČS is set to maintain its business model. “We do not see any reasons for a major change in our business or risk model, as they proved to be effective. We have always put emphasis on the quality of our loan portfolio and have assessed all loan applications carefully,” she said. However, she wouldn’t develop on the impact on the business. “Generally, it is too early to elaborate the full impact of the crisis,” she said.

Monika Klucová, a spokeswoman with KB said that her bank also didn’t freeze and didn’t limit any services. “KB is doing business as usual,” she said.

KB is a universal bank, and 95 percent of its income comes from activities for retail clients and companies. The universal business model of KB is stable, no matter if the market goes up or down. “We do not see any reason to change our business model, which has turned out to be strong and stable despite the financial crisis.”

Klucová declined to comment on setbacks in the interbanking matters, as it is “internal information.” She said however that KB’s lending conditions haven’t been influenced by the financial crisis in any way. “A conservative approach to lending has proved its worth for us. The loan portfolio quality has not deteriorated,” she said.

So far, KB didn’t tighten conditions for granting mortgage loans because “they were put in place prudently in the past.” “Our clients can currently obtain a mortgage loan under the same conditions as last year. For the time being we are not planning to tighten the conditions for granting mortgage loans,” she said. However, the bank is monitoring both the Czech and foreign markets and evaluates risks. “In the event of disproportionate negative trends, we would consider the options for tightening the conditions.”

As for corporate clients, KB doesn’t consider any change or tightening of lending conditions for corporate clients from the perspective of risk management. “Naturally, from the business perspective it depends on the development of the cost of money on the interbank market,” she said. KB will publish its three-quarter results on Nov. 7.

ČSOB and UniCredit failed to comment on the interbanking and shortage of lending products for corporate and retail clients by CBW press time.

Second tier bank looks to the top

Both Raiffeisenbank Czech Republic and GE Money Bank Czech Republic said they aren’t affected by the interbanking crunch. Though, both banks have been blamed in the past of taking too much risk in mortgage lending in order to get as much market share as possible from the big four. However, Tomáš Kofroň, spokesman for Raiffeisenbank, said that his bank was one of most conservative banks in a lending business, with “high requirements” on clients’ payment financial capacity, both private and corporate. “Our loan portfolio is very healthy,” he said, adding that in mortgages nonperforming loans are about 0.5 percent of the portfolio.

However, as the situation is not standard in the market, the bank had to strengthen its policy. This meant that in mortgages it won’t offer mortgages for 100 percent of real estate and it’s also strengthening rules for mortgages without proof of income. If previously the bank granted up to 70 percent of the real estate price, now it’s only 50 percent. There are some 20 further minor changes in mortgages.

Also, he said that in corporate business the bank can see strengthening of conditions in certain segments such as developers. Yet, it’s not about freezing these products, but strengthening the conditions in order to protect everybody, the bank, shareholders and clients, he said. However, “we still continue in both real estate and corporate lending, but couldn’t comment on any transaction. Just one example: we have increased the loan for ECM last month, which was widely communicated,” he said.

Despite these cuts, the bank doesn’t expect a negative impact on its results. “In the first half of 2008 we have almost doubled our net profit to a record Kč 800 million (€30.7 million). Also, Raiffeisen International confirmed its profit expectations about €1 billion for this year—these expectations remain unchanged,” he said.

“Our business runs as usual,” said Pavla Hávová, spokeswoman for mortgage lender Hypoteční banka. She said that her bank doesn’t refinance in the money market, but issues mortgage bonds, which are usually sold to the ČSOB group. She declined to comment on her bank’s economic outlook for 2008, but said that the bank “isn’t affected by the financial crisis and we expect to meet our targets.” She argued that her bank’s business and risk models work very well. “The proof is that we are number one in the [mortgage] market and our business in the last months has been better than in 2007. We therefore do not plan any significant changes [in the risk models],” she said. The bank doesn’t expect a slowdown in mortgage credit demand. “Statistics from January to September 2008 show that [demand] is keeping at the 2007 level,” she said.

Backed by a strong father

The sixth-largest Czech retail bank, GE Money Bank, feels comfortable to swim in the Czech waters these days. “The Czech bank sector is in a very good condition,” said Blanka Bělovská, a spokeswoman with the bank.

While the obligatory capital adequacy ratio (CAR) is set at 8 percent in the Czech Republic, GE Money Bank’s CAR is almost 21 percent or 2.5 times higher. “GE Money Bank’s credit and investment policy is conservative, responsible and cautious in long term. GE Money Bank has also diversified portfolio of loans and deposits, and we were not engaged in large real estate projects. Protection of our clients’ financial resources is our priority,” she said. “We strictly avoid any potential risky businesses / investments and therefore we do not face any problems or losses due to the financial crisis.”
However, the bank decided to stop providing 100 percent mortgage loans as of October. “This is the only provision for which we preventively decided, not because of the crisis, but due to relating expected economic slowdown. We try to protect our clients against excessive indebtedness, and this means temporarily lower upper limit of provided mortgages of 80 percent of the securing property value,” she said.

GE Money Bank is owned by the U.S.-based General Electric. In September, rating agencies Standard & Poor’s, a division of publisher McGraw-Hill Companies, and Moody’s Investors Service reaffirmed GE’s AAA credit rating. “As a group, we have enough [of our] own financial resources, and we are financially sound. Due to this fact, GE Money Bank in the Czech Republic even does not need to borrow on the interbank market,” she said, concluding that international financial market turbulences “don’t endanger GE Money Bank’s stability, also thanks to stability of the whole GE concern and Czech bank market.”

GE Money Bank has already been operating 10 years in the Czech Republic. “Our continual growth is secured by strict adherence to responsible lending and investment principles,” she said.

The largest Czech consumer credit provider, Home Credit International, said that the credit crunch hasn’t taken a toll on its business so far, even if costs of funds have been increasing. “Our costs of funds have been reacting to the markets and increasing because we are funded ‘publicly’ through standard financing instruments such as syndicated loans and securitization,” said Erich Čomor, general manager of Home Credit for the Czech Republic and Slovakia. As a result, the group is taking reasonable measures to decrease its relative cost base to ensure that it maintains a healthy profitability.

“On the liquidity side we are safe, as our financing instruments continue to be upheld throughout the crisis. Besides, we have a very sound liquidity backing from our [financial group and Home Credit majority owner] PPF shareholders,” Čomor said.

A cut well expected

A recent study of ČS pointed that ČNB seems ready to cut the basic interest rate by at least 25 basis points (bps) at its November meeting. Some analysts were however pointing at a deeper cut of 50 bps, in agreement with the cut operated by the European Central Bank (ECB) in a coordinated move with the U.S. Federal Reserves and four other European central banks on Oct. 8, 2008. However, the recent depreciation of the crown might release the pressure on ČNB and only ask for the 25 bps. “Even in the past, the ČNB behaved quite independently compared to the ECB,” Navrátil said. The only slight chance to go for the 50 bps cut is if the crown starts to appreciate again. “Exporters would appreciate the cut, but the crown is now close to its fundamentals, so a 25 bps cut is rather appropriate, as it’s consistent with expectations for a slowdown in the whole economy,” he said. Another cut in the Czech basic interest rate is expected at the beginning of 2009."

Hungary’s already ailing economy ill equipped for global crisis

2008-10-27T18:50:00.000+01:00

Hungary’s already ailing economy ill equipped for global crisis: "Hungary’s already ailing economy ill equipped for global crisis
By: Anna Sieczkoś, 27. 10. 2008,

One week after the European Central Bank (ECB) offered to lend troubled Hungary up to €5 billion (Kč 130 billion) to support liquidity on the local interbank market, on Oct. 22 Hungarian Central Bank (MNB) raised its benchmark interest rate by a staggering 300 basis points, lifting a two-week deposit rate to 11.5 percent, the highest since July 2004. This step by Hungarian monetary authorities was aimed at supporting the forint, which has been dramatically losing value, dropping 14 percent against the euro over the past three weeks.

Hungarian Finance Minister János Veres recently announced that the Cabinet of Ferenc Gyurcsány (Hungarian Socialist Party, MSZP) (pictured) is working on measures to strengthen forint, bond and stock markets, and to reduce the budget deficit from 5 percent of gross domestic product (GDP) in 2007 to less than 3 percent in 2009. As the government reforms need time to bear fruit, the central bank was expected to support the forint and the Hungarian economy during the current crisis. However, nobody expected such far-reaching consequences. Analysts say the economy will eventually pay heavily for the rate rise. Even before the move, investment banks and think tanks cut GDP growth forecasts for the whole Central and Eastern European (CEE) region, including Hungary. On Oct. 17 the Hungarian Ministry of Finance also issued a new GDP growth forecast for 2009 of 1.2 percent against a previous 3 percent figure.

“The central bank’s move may give temporary support to the forint, but the country will likely need more money from the International Monetary Fund (IMF) to stabilize its markets in a lasting way,” Ryszard Petru, until recently the chief economist of Warsaw-based Bank BPH, told CNBC Biznes TV station. He said that Hungary is acting desperately, sending negative signals to the market that it is unable to handle the crisis.

Przemysław Kwiecień, chief economist with Warsaw brokerage X-Trade Brokers Dom Maklerski, told CBW that in order to reinforce the positive effect of the central bank rate increase, the government should definitely deliver on promises to reduce its spending. “Such a move could, however, be deadly not only for the political support of the government but also for the short-term economic development that is hovering on the brink of recession,” he warned.

Icelandic scenario to be avoided

Analysts agree that the risk of substantial capital outflow from Hungary must be significant if the central bank put the long-term prosperity of Hungarian society at stake and voted for strong increase in interest rates. Extremely expensive credit, more than three times as costly as in the Czech Republic, will definitely work to the detriment of the Hungarian economy, which in the regional comparison has been developing slowly in the last four years. Some analysts compare the situation in Hungary to recent events in Iceland, a country which is endangered by insolvency after bailing out the three biggest banks.

Both countries, in fact, suffer from huge current account deficits and plummeting currencies. “Hungary and Iceland have nothing in common but thermal sources and the relatively small size of their economies. Hungary has €17 billion reserve currency, Iceland had hardly any,” Rother Andras Simor, head of the Hungarian Central Bank, said during a TV appearance.

“For Hungary I don’t expect the Icelandic scenario at the moment,” Petru agreed.

Petru said the decision of the central bank—which was negatively interpreted by investors, who consider the CEE countries as a homogenous group—already took a toll on other economies. Among regional currencies the Polish złoty was hit the strongest, on Oct. 22 losing 5 percent against the dollar and 3.3 percent against the euro, coming back to exchange rates seen 18 months ago. The Czech crown was more resilient, dropping 2.6 percent against the dollar and 0.9 percent against the euro. It seems that the rate increase didn’t come much to the rescue of forint, which on Oct. 22 further tumbled 3.2 percent against the dollar and 1.5 percent against the euro. A massive retreat of investors from the CEE region wasn’t seen only on foreign exchange but also on equity markets, with Poland again suffering the most with the WIG20 blue-chip index losing 7.6 percent against the Oct. 21 close. Prague PX Index lost 2.4 percent and Budapest BUX Index lost 3.5 percent Oct. 21.

Hungary weak on solvency criteria

“Hungary, where public debt amounts to 66 percent of GDP and one-third is denominated in foreign currencies, is strongly dependent on foreign investors, and now it is losing their confidence,” Kwiecień said. “Normally, high public debt and budget deficit would result only in a higher risk premium. However, under the current circumstances investors do not want to lend to anyone carrying a credit risk. That makes the situation really complicated. In most countries, governments are taking advantage of favorable conditions on their debt markets and can fund extraordinary measures directed at stabilizing their banking sectors. In Hungary also, however, the bond market is in distress, so help needs to be obtained outside,” he added. After the increase was announced, the state debt agency scrapped an auction of government bonds as bids failed to reach even half the 40 billion forint offer. Similar situations also occurred several times in recent weeks.

According to an analysis published by business intelligence site Stratfor.com, there are three major criteria that decide the country’s ability to raise capital during a credit crunch, whether by rising taxes or issuing bonds: government spending share in the GDP, government budget deficit and the level of national indebtedness. That is why the most seriously threatened European states are currently France, Italy, Greece and Hungary, which are running serious budget deficits despite an already high level of government debt. These four countries are closely followed by Romania, Poland, Slovakia, Bosnia, the Netherlands, Portugal and Lithuania.

How did Hungary fall into trouble?

Hungarian problems are a consequence of lax fiscal policies over the last several years. “The economic policy in Hungary in the last few years has to be described as controversial if not to say irresponsible,” Kwiecień assessed. Everything began during the global recession of 2001 as the Hungarian economy showed surprising resilience to the global slowdown, growing by over 4 percent against Poland and the Czech Republic, which decelerated to less than 2 percent GDP growth. This relatively comfortable situation tempted the government to hold a high budget deficit while neighbors adopted much more stringent fiscal polices. As a result, Hungary has increased its government debt since then, while other CEE countries have experienced significant reductions in liabilities. Finally, the Gyurcsány government, under pressure of European Commission and facing a budget deficit of 9 percent of GDP, imposed measures radically curbing public spending in 2007. “Reduction in public spending hurt the purchasing power of consumers, which means weak domestic demand. Unfortunately, the Hungarian economy suffered from a double whammy of weak internal and external demands when the global economy turned into recession in 2008, which spells serious recession fears in Hungary. The necessary fiscal austerity reforms were done too late,” Kwiecień remarked. The end result is that the Hungarian economy, according to available data and forecasts, will grow by less than 1.5 percent in each of three years between 2007 and 2009, losing distance to other CEE economies.

“The monetary policy, due to its ambiguous nature, didn’t help the Hungarian economy, either,” Kwiecień added. “The managed currency exchange rate cannot be reconciled with inflation targeting as pursued by the Hungarian Central Bank. The monetary failure also had a negative impact on the economy and the country’s macro data, especially high inflation which is still close to 7 percent despite deep recession.”

The experts agree that the most urgent topic now is helping Hungary sustain the crisis on global credit markets, which keeps it without financing. Later on, material changes to Hungarian economy can be put in place. “As soon as the situation normalizes, the Hungarian government should keep the fiscal policy tight and introduce a credible euro adoption program. These are steps necessary to attract international investors back to the economy,” Kwiecień said, adding that the Hungarian crisis should also serve as a lesson for other developing economies concerning the dire consequences of extensive fiscal expansion."

And So It Ends - Hungary's Government Announces Foreign Curreny Loan Wind-up...

2008-10-27T17:45:00.001+01:00

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And So It Ends - Hungary's Government Announces Foreign Curreny Loan Wind-up Package

via Eastern Europe Economy Watch by Edward Hugh on 10/24/08

Hungarian Prime Minister Ferenc Gyurcsány announced this morning (Wednesday) that the government had reached an agreement with commercial banks intended to protect the interests of those who have taken out foreign currency loans.

The agreement, which is expected to be signed early next week, has three key components:

1) At the request of the debtor the banks will allow the duration of the loan to be extended (with fixed monthly instalments) so that the depreciation of the forint "does not place an unbearable burden on the debtors".

2) FX debtors who deem that exchange rate fluctuations carry excessive risks for them will be allowed to convert their foreign currency-based loan to a forint loan. In this case the banks "will accept this request and make the switch without extra charges".

3) If a debtor finds him- or herself in a position where he or she cannot pay the monthly instalments, e.g. due to becoming unemployed, the banks will be amenable to transitionally reducing the instalments or even suspending them entirely at the request of the debtor.

I say "agreement" here, but in fact the banks had little alternative, since Gyurcsány made it plain to them that if they did not agree then legislation would be introduced to enforce the government package.

So here, right now, and on 23 October 2008 in Budapest ends, in my opinion, a fashion for taking out non-local currency denominated loans, which lasted the best part of a decade and sewpt across half a continent, and especially in Central and Eastern Europe . Basically government after government in one CEE country after another will now find themselves with little alternative but to follow Hungary's lead, as the parent banks turn off the tap on the one hand and the citizens themselves grow more and more nervous on the other.

The situation is in fact a little bit complicated, since (unless there is some part of the fine print which has not been made public yet) we have to assume that the conversion rate be the going market one, which will mean that many of those who such mortgages will take some form of capital loss on the transfer, which can thus only be seen as some form of "late in the day" protection against subsequent falls in the value of the forint. Jiri Stanik at Wood & Co estimates that most bank clients took out their FX loans at a level of around CHF/HUF 170, so despite the fact that the forint has depreciated by some 30% against CHF over the last two months, its current level (HUF/CHF is about 185 at the time of writing) only represent s an 8/9% depreciation from the average client purchase price. Most of the risk and all the really bad news will come for these mortgage holders if the forint were to continue to depreciate further against CHF. Will this depreciation continue? Well, even we economists don't really know the answer to that question, and certainly Hungarian householders have no idea at all, which is one very good reason why most of these clients may decide to get out now. Cerainly they will probably be uncomforable with the realisation that they have suddenly all become day traders in the forward HUF/CHF swap market using their homes as security.

Also the rate of interest to be charged on the HUF morgtgages will be based (it would seem, again there are no details) on some mark-up or other over the current base rate of the the NBH, which was, we will remember hiked to 11.5% yesterday. So at the end of the day the people who make the transition will take a (small, at this point) capital loss, but at the same time their short term interest servicing payments will skyrocket (this is presumeably why Gyurcsány has insisted on their being able to extend the term of the payments) . Thus, in terms of the macroeconomic recession, here we go.

For this all to form part of a coherent rational policy (perhaps a very large assumption indeed at this point) , it can only suggest one thing, in my opinion: that the base rate hike is a TEMPORARY support for the forint while people move over (which we could expect to see in the form of a flood, rather than a trickle - see the point about "herd behaviour" below). Basically when you have half your army trapped in an excessively advanced position, you need the heavy artillery to lay on some cover while you pull them back.

Once the troops are safely back under cover, then, in my humble opinion, we should anticipate a rapid easing cycle on the part of the NBH, and a sudden tanking in HUF partities, since the looming priorities will be to ease distress on all the new HUF mortgage payers, and an attempt to "jump start" a new export-driven Hungarian economy. I think it is important to bear in mind that Hungary is now about to head into quite a severe recession, and the fiscal stimulus door is effectively closed. Monetary easing is the only real policy tool the Hungarian authorities have available. And remember, we are going into all of what is now to come with national morale severely weakened by two years of policy measures which didn't work, to cut a very long story down to a very, very short one.

In other words the current situation is like having your population distributed across two very high buildings, one of which is about to collapse (or at least disappear), and the Hungarian government has just thrown a plank across from one building to the other so that people can "move over" in single file, before the one which is about to go, goes. The people in the other building may suffer from overcrowding and shortage of food, but they will at least be "safe". But the big danger might be, just how many will get trampled in the rush?

Basically, and to cut another very long story down into a very, very short one, the building which is about to disappear is the one which was to have housed Hungary (and several other of the EU12) as a full member of the Eurozone. This, ever more distant possibility in recent months, is now about to move off into a much longer term futures, and it is this distancing, of course, which makes all the forex borrowing suddenly unsustainable. The man who has been hanging desparately over the parapet by his fingernails for two years, now finally lets go.

Plus there is still the thorny little issue of just how Hungary is going to fund the conversions, and how much bad news there might be for the banks here.

"We think the most important announcement at this stage is the possibility to convert CHF loans to HUF. If households chose to do this it would ultimately mean a switch in FX mismatch from households to banks (who would then hold HUF assets but CHF liability). Banks in turn would then need to close their FX mismatch, through FX swaps (buying CHF).........It's not clear who would provide sufficient HUF liquidity to do this. Ultimately the NBH would presumably provide liquidity to avoid banks being left with a significant FX mismatch."
Martin Blum, Gyula Tóth, UniCredit, Vienna

At the end of August total housing loans were running at around 3,380 billion HUF or about EUR 12 billion equivalent at todays prices. Of these around 18 billion HUF (or 53%) were fx housing loans. Which means there are something like 6.5 billion euro in fx housing lonas which could be translated over. To this could be added another 1,500 billion HUF in mortgage financed personal loans (so say around another 5 billion euros to cover this). These numbers put the recent 5 billion euro loan from the ECB in some sort of perspective I think.

My impression is that this move by the Hungarian administration will soon be followed by one government after another across the other central and Eastern European Economies where forex mortgage borrowing had become so popular. So basically, the situation is that Hungary can, to some extent, protect its citizens from excessive exposure in times of turbulence, via this channel. The foreign banks who have been providing this service, and who in the main come from other EU member states, will then be left to pick up the exposure tab themselves, and my guess is that several of them will need to seek protection via the EU15 bank support scheme thrashed out in Paris on 12 October last, in just the same way that other financial entities have been receiving protection from the US Sub-prime write-downs.

In the meantime, we can expect to see the shares of the main banks involved coming under severe attack. Erste Group Bank AG, Austria's biggest publicly traded bank, lost 1.95 euros, or 8.8 percent, on Tuesday to hit 20.10, a five-year low, while Italy's Unicredit - another very exposede bank in CEE terms - fell to an 11-year low in Milan this morning (Wednesday) on market speculation the company will need to further strengthen its already recently "strengthened" finances. Italy's biggest bank by assets declined as much as 8.8 percent to 1.90 euros, its lowest price since September 1997. Unicredit is now down 65 percent since the beginning of the year and shares in the bank were again suspended from trading earlier today due to excessive declines.

A Ten Year Craze Comes To An End

As I say above "and so it comes to an end". A phenomenon which in many ways has served to characterise an epoch is now being drawn to a close, and as my own personal contribution to commemorating this pretty historic moment, I would like to take you all back a deceade or so to take a look at how the whole thing got started in the Austria of the late 1990s, since it was in Austria that the fashion for CHF mortgages really took off, and it is no coincidence that in Hungary it has been CHF and not euro denominated borrowing (as for example in the case of the Baltics or Romania) which has been the hallmark, since the Asutrian banks have played a key role in the Hungarian "transition". Dimitri Tzanninis explains the origins of Autrian CHF borrowing as follows:

The practice of borrowing in foreign currency (mainly Swiss francs) began in the western part of the country, where tens of thousands of Austrians commute to work in Switzerland and Liechtenstein. This partly explains why the share of these loans was higher in Austria, even during the 1980s. Word of mouth and aggressive promotion by financial advisors helped spread the popularity of these loans to the rest of the country. By the mid-1990s, newspaper ads placed by banks began to appear, fueling public interest.

Now Dimitri Tzanninis refers to this as an example of "herd behaviour" (see note at foot of post, and of course herd behaviour is the word, since his is about fads and fashions, and largely "non-rational behaviour - since if people understood the risk they were taking on board, then basically they wouldn't do it, and it is precisely herd-behaviour that we are now about to see in action again as people "unleverage" from the CHF as best they can). So, herd behaviour is essentially a non-linear process, and one which in this case is characterised by a lot of press and "word of mouth" driven "copycat"decision taking. The following charts of news stories in the Austrian press sum the situation up pretty well:

Herd Behaviour

For the record book I reproduce below the explanation of the herd behaviour phenomenon offered by Dimitri Tzanninis.

"Herd behavior occurs when people do what others do rather than rely on their
own (incomplete) information, which might be suggesting something different
(Banerjee, 1992). The suppression of private information could lead to
"information cascades" when decisions are made sequentially and a large enough
number of people choose identical actions. In such settings, the decisions of a
critical few people early on are enough to tilt group behavior toward a certain
direction. Mimicking the behavior of others might be rational because of
uncertainty about one's own information as well as the need to economize on
information-gathering costs. Rational herd behavior is the subject of a recent
strand of behavioral finance (see Montier, 2002, for an introduction). "

Herd behavior can arise in a variety of environments, including in financial markets. However, it is difficult to disentangle empirically the effects of macroeconomic or other fundamental determinants from those caused by herd behavior. Herd behavior often results in volatility because it is susceptible to abrupt shifts or reversals, and thus has the potential to destabilize markets.

Empirical studies have shown that the dynamics of herd behavior often resemble an S curve: initially only a few adopt a certain behavior, but, past a certain critical mass, a take-off state takes hold where a rapidly growing number of people adopt this behavior. Toward the end of this process, a moderation of the dynamics takes place as the potential pool of adoptees is exhausted.

References:

Banerjee, A. V., 1992, "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, Vol. CVII(3), pp. 797-817.

Montier, J., 2002, Behavioural Finance: Insights into Irrational Minds and Markets (Chichester: John Wiley & Sons Ltd.)

Waschiczek, W., 2002, "Foreign Currency Loans in Austria—Efficiency and Risk Considerations," in Financial Stability Report 4, OeNB, pp. 83-99 (Vienna: Oesterreichische Nationalbank).

And to close this little commemoration of the closing of an epoch, here is a post I put up on this blog on 5 November 2007.

Swiss Franc Morgtages in Hungary

The use of non-local-currency denominated loans has become a widespread phenomenon in Eastern Europe in recent years. In Hungary the most common currency for such purrposes is the Swiss Franc and around 80% of all new home loans and half of small business credits and personal loans taken out since early 2006 have been denominated in Swiss francs. A similar pattern of heavy dependence on foreign currency denominated loans is to be found in Croatia, Romania, Poland, Ukraine (US dollar) and the Baltic States, although the mix between francs, euros, the dollar and the yen varies from country to country.

So let's look at the extent of the issue in Hungary, and some of the likely implications. First off, here's a chart showing the evolution of outstanding mortagages with terms over 5 years since the start of 2003. As we can see the outsanding debt is now over 5 time as big as it was then.

Now if we look at the growth of forint denominated mortgages over the same period, we can see that while they initially expanded very rapidly, they peaked around the start of 2005, and since that time they have tended to drift slightly downwards.

Then if we come to look at the growth of non-forint mortgages, we will see that since early 2005 the rate of contraction of such mortgages has increased steadily.

Finally, if we look at the distribution of non-forint mortgages between those in euros, and those in "other" currencies (which may contain some yen, and some USD mortgages, but in the main will be Swiss Franc ones) we can see that those in euro form only a very small part of the total.

It is perhaps also worth pointing out that the fashion for non-forint loans is not restricted solely to mortgages, car loans and other longer duration personal loans also tend to be denominated in Swiss Francs or other currencies. The reason for this is obvious, the rate of interest is cheaper. But this non forint loan predominance has two important consequences.

In the first place the Hungarian central bank does not have sufficient control over monetary policy inside the country, being to some significant extent influenced by monetary policy in Switzerland, a country we may note which is not even inside the European Union. Secondly, the difficulties which would present themselves in the event of any substantial reduction in the value of the forint would be considerable - the is known as the translation problem, and is ably reviewed by Claus in this post here - and as a result the central bank is one more time a prisoner of others in terms of monetary policy, since it cannot take interest rate decisions which might influence excessively the swiss franc-forint crossover rate.

The fashion for borrowing in Swiss francs really took off in Eastern Europe after the Swiss National Bank dropped interest rates to 0.75% in 2003 in order to stave-off a perceived deflation threat, a move which at the same time converted Switzerland into the cheapest source of loan capital in Europe. External lending in Swiss francs reached $643 billion in 2006, according to data from the Bank for International Settlements . The huge scale of the borrowing in fact drove the Swiss franc to a nine-year low against the euro, and has lead to an accelerating slide in its value over the last two years - even though by this point the Swiss National Bank had been busy raising rates (Swiss interest rates have now been increased 7 times since the 2003 trough). The extreme weakness in the Swiss Franc is in fact rather perverse (shades of Japan, of course, here), since currently Switzerland enjoys the highest current account surplus in the developed world (some 17.7% of GDP in 2006). At the same time the Swiss hold more than $500 billion in net foreign assets, making them in these terms the wealthiest nation on earth.

A recent issue of the Bank for International Settlements publication Highlights of International Banking and Financial Market Activity has some revealing comments on the Swiss situation(the data used for the report came from 2006):

Total cross-border claims of BIS reporting banks expanded by $1 trillion in the last quarter of 2006. After more modest growth in mid-2006, a pickup in interbank claims accounted for 54% of this expansion. A surge in credit to nonbank entities contributed $473 billion, pushing the stock of cross-border claims to $26 trillion, 18% higher than in late 2005.

The flow of credit to emerging markets reached new heights through the year 2006. Claims on emerging markets grew by $96 billion in the final quarter of 2006, bringing the volume of new credit throughout the year to $341 billion. This amount exceeded previous peaks ($232 billion in 2005 and $134 billion in 1996), both in nominal value and in terms of growth. The current annual growth rate has risen to 24%, having surpassed for the sixth consecutive quarter the previous peak of 17% recorded in early 1997.

Emerging Europe overtook emerging Asia as the region to which BIS reporting banks extend the greatest share of credit. Since 2002, growth in claims on the region has consistently outpaced that vis-à-vis other regions. With a record quarterly inflow, emerging Europe received over 60% of new credit to emerging markets, bringing its share in the stock of emerging market claims to 34%. Less of the new credit went to the major borrowers (Russia, Turkey, Poland and Hungary) than to a number of smaller markets, notably Romania and Malta, as well as Ukraine, Cyprus, Bulgaria and the Baltic states.

The currency denomination of cross-border claims on emerging Europe tilted further towards the euro. In the stock of claims outstanding, the euro and dollar shares were 44% and 31%, respectively, but the gap in the latest flow data was more pronounced (61% and 5%). While the sterling share has remained close to 1%, the yen has lost ground to the Swiss franc, thus continuing a trend seen over the last six years. Yet there is little evidence in the cross-border data of unusual borrowing in Swiss francs that might correspond to Swiss franc-denominated retail lending in several countries. Borrowing in the Swiss currency remains on average below 4% of cross-border claims, and exceeds 10% only in Croatia and Hungary.

Nearly 20% of reporting banks' foreign claims were in the form of funds channelled to emerging market borrowers. Claims on residents of emerging Europe continued to account for the largest share of these funds.

So, although the BIS find "little evidence in the cross-border data of unusual borrowing in Swiss francs that might correspond to Swiss franc-denominated retail lending", they do make an exception in the cases of Hungary and Croatia, where they note that lending in Swiss francs to retail clients reaches over 10% (and of course in the Hungarian case well over 10%) of the total retail loans in those countries. Indeed, as I indicate above, swiss franc loans now seem to account for over 80% of all newly generated housing related credit in Hungary. The reason why Hungary has gone for Swiss franc rather than euro denominated loans undoubtedly has to do with the role of the Austrian banking sector in Hungary, as is explained in my fuller posting on this topic linked to below.

Additional References On Swiss Franc Loans and "Translation"

For fuller examination of just why it is that Switzerland (or for that matter Japan) have such low interest rates, see my "Swiss Franc Loans and Ageing" post.

For an examination of the potential implications of the presence of all these foreign currency loans across the EU10 in the event of any generalised emerging markets crisis see Claus Vistesen "Translation Risk in the Baltics and Other Matters".

Balance Sheet Consequences: The Academic Research

Well, given what I am saying above about the rapid and imminent demise of foreign exchange loans among Central and East European nationals, it is clear that the topic which is now about to come back into fashion (and to replace the forex loans themselves as the centre of attention) - at least among theoretical economists) is that of the so called balance sheet cosnequences of excessive forex leveraging, so to give people some background, and a bit of a push start, I have hastily compiled a brief reading list on the topic.

Do Balance-Sheet Effects Matter for Brazil? Felipe Farah Schwartzman, May 2003

The past ten years have seen a number of currency crises, typically followed by a sharp drop in output in the countries involved. An explanation advanced for both the crisis and the recession is that firms in these countries had a large amount of debt indexed in foreign currency (Krugman, 1999). The exchange rate devaluation left the firms insolvent, reducing credit and production in the economy. Apart from crisis, balance-sheet effects have been advanced as an explanation for the "fear of floating" detected by Calvo and Reinhardt (2000) in developing economies in normal times.

Krugman, P. (1999), "Balance Sheets, the Transfer Problem and Financial Crisis," in: International Finance and Financial Crises, P. Isard, A. Razin and A. Rose (eds.)

For the founding fathers of currency-crisis theory ..........the emerging market crises of 1997-? inspire both a sense of vindication and a sense of humility. On one side, the number and severity of these crises has demonstrated in a devastatingly thorough way the importance of the subject; in a world of high capital mobility, it is now clear, the threat of speculative attack becomes a central issue - indeed, for some countries the central issue - of macroeconomic policy. On the other side, even a casual look at recent events reveals the inadequacy of existing crisis models. True, the Asian crisis has settled some disputes - as I will argue below, it decisively resolves the argument between "fundamentalist" and "self-fulfilling" crisis stories........ But it has also raised new questions.

One way to describe the problem is to think in terms of Barry Eichengreen's celebrated distinction between "first-generation" and "second-generation" crisis models. First-generation models, exemplified by Krugman (1979) and the much cleaner paper by Flood and Garber (1984), in effect explain crises as the product of budget deficits: it is the ultimately uncontrollable need of the government for seignorage to cover its deficit that ensures the eventual collapse of a fixed exchange rate, and the efforts of investors to avoid suffering capital losses (or to achieve capital gains) when that collapse occurs provoke a speculative attack when foreign exchange reserves fall below a critical level.

Second-generation models, exemplified by Obstfeld (1994), instead explain crises as the result of a conflict between a fixed exchange rate and the desire to pursue a more expansionary monetary policy; when investors begin to suspect that the government will choose to let the parity go, the resulting pressure on interest rates can itself push the government over the edge. Both first- and second-generation models have considerable relevance to particular crises in the 1990s - for example, the Russian crisis of 1998 was evidently driven in the first instance by the (correct) perception that the weak government was about to be forced to finance itself via the printing press, while the sterling crisis of 1992 was equally evidently driven by the perception that the UK government would under pressure choose domestic employment over exchange stability.

In the major crisis countries of Asia, however, neither of these stories seems to have much relevance. By conventional fiscal measures the governments of the afflicted economies were in quite good shape at the beginning of 1997; while growth had slowed and some signs of excess capacity appeared in 1996, none of them faced the kind of clear tradeoff between employment and exchange stability that Britain had faced 5 years earlier (and if depreciation was intended to allow expansionary policies, it rather conspicuously failed!) Clearly something else was at work; we badly need a "third-generation" crisis model both to make sense of the recent crises and to help warn of crises to come.

In the paper which follows Krugman sketches out yet another candidate for third-generation crisis modeling, one that emphasizes two factors that had been omitted from previous formal models to date: the role of companies' balance sheets in determining their ability to invest, and that of capital flows in affecting the real exchange rate. The model was at that point (and as Krugman himself says) quite raw, with lots of loose ends hanging about. However, it did seem to tell a story with a much more realistic "feel" than some of the earlier efforts. It could be hoped that now that he has had time to recover from the shock of his recent Nobel, he may get interested once more in this earlier centre of his attention, since the model badly needs updating, and in particular to take account of the shift in the risk away from the corporate and towards the household balance sheet.

Balance Sheet Effects, Bailout Guarantees and Financial Crises
MARTIN SCHNEIDER UCLA and AARON TORNELL UCLA and NBER

This paper provides a model of boom-bust episodes in middle income countries. It features balance of- payments crises that are preceded by lending booms and real appreciation, and followed by recessions and sharp contractions of credit. As in the data, the non-tradables sector accounts for most of the volatility in output and credit. The model is based on sectoral asymmetries in corporate finance. Currency mismatch and borrowing constraints arise endogenously. Their interaction gives rise to self-fulfilling crises.

In the last two decades, many middle-income countries have experienced boom-bust episodes centered around balance-of-payments crises. There is now a well-known set of stylized facts. The typical episode began with a lending boom and an appreciation of the real exchange rate. In the crisis that eventually ended the boom, a real depreciation coincided with widespread defaults by the domestic private sector on unhedged foreign-currency-denominated debt. The typical crisis came as a surprise to financial markets, and with hindsight it is not possible to pinpoint a large "fundamental" shock as an obvious trigger. After the crisis, foreign lenders were often bailed out. However, domestic credit fell dramatically and recovered much more slowly than output.

This paper proposes a theory of boom-bust episodes that emphasizes sectoral asymmetries in corporate finance. It is motivated by an additional set of facts that has received little attention in the literature: the tradables (T-) and nontradables (N-) sectors fared quite differently in most boom-bust episodes. While the N-sector was typically growing faster than the T-sector during a boom, it fell harder during the crisis and took longer to recover afterwards. Moreover, most of the guaranteed credit extended during the boom went to the N-sector, and most bad debt later surfaced there. Our analysis is based on two key assumptions that are motivated by the institutional environment of middle income countries. First, N-sector firms are run by managers who issue debt, but cannot commit to repay. In contrast, T-sector firms have access to perfect financial markets. Second, there are systemic bailout guarantees: lenders are bailed out if a critical mass of borrowers defaults.

And please note the last sentence: "lenders are bailed out if a critical mass of borrowers defaults", this, I imagine, is what we are about to see happen next.

A Balance Sheet Approach to Financial Crisis
Mark Allen, Christoph Rosenberg, Christian Keller, Brad Setser, and Nouriel Roubini :

The paper lays out an analytical framework for understanding crises in emerging markets based on examination of stock variables in the aggregate balance sheet of a country and the balance sheets of its main sectors (assets and liabilities). It focuses on the risks created by maturity, currency, and capital structure mismatches. This framework draws attention to the vulnerabilities created by debts among residents, particularly those denominated in foreign currency, and it helps to explain how problems in one sector can spill over into other sectors, eventually triggering an external balance of payments crisis. The paper also discusses the potential of macroeconomic policies and official intervention to mitigate the cost of such a crisis.

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