Addressing Emerging Europes Vulnerabilities: Weak Domestic Markets - PowerPoint PPT Presentation

Addressing Emerging Europe’s Vulnerabilities: Weak Domestic Markets and Excessive Forex Exposures A Coordinated Approach – “Vienna Plus” European Bank Coordination (“Vienna”) Meeting Athens, 19 March 2010 Piroska M. Nagy EBRD

Key messages � Strong and sustained growth in emerging Europe is in the interest of each and every stakeholders present � Time is right to address the region’s twin vulnerabilities: excessive reliance on foreign capital and forex lending to unhedged borrowers � reforming the growth model � There is, again, a collective action and coordination problem: for banks; regulators; IFIs � Call for “Vienna Plus” � A road map - let’s do it!

Capital inflows strongly correlated with credit growth during 2005-08 (Per cent) 90 90 Ukraine R 2 = 0.2988 80 80 Average credit growth between mid-2005 and mid- Azerbaijan 70 70 Kazakhstan Albania Estonia 60 Romania 60 Latvia Lithuania Serbia 50 50 Russia 2007 40 40 Tajikistan Bulgaria Moldova 30 FYR 30 BiH Croatia Slovenia 20 20 Czech Rep. Hungary Poland 10 10 0 0 -20 0 20 40 60 80 100 120 140 160 180 200 Median growth of BIS lending between mid-2005 and mid-2007 Source: EBRD Transition Report 2009

Share of FX borrowing is high in many countries – significant part is unhedged Percent 100 90 80 70 60 50 40 30 20 10 0 a a a a a a n a y * n a d a . p e i i i i i i i r v i a a n n n v n b t r a s e n a t t o a a t o a r a s s g i s R a o g d l e a u t b u i n h o L s S r k l r l R h l h u u k o P C k A i E c j t B H a M U i a e z L T z a C K End-June 2004 End-June 2008 Source: EBRD Transition Report 2009

Foreign bank presence is correlated with a higher share of lending in FX 0.9 Share of foreign currency lending in total LAT 0.8 BUL EST CRO SER 0.7 ALB domestic lending 0.6 UKR 0.5 LIT AZE HUN KAZ ARM MOL 0.4 0.3 POL FYRM TUR RUS 0.2 0.1 SLV 0.0 0.0 0.2 0.4 0.6 0.8 1.0 1.2 Asset share of foreign-owned banks Source: EBRD Transition Report 2009

Weak reliance on domestic savings Loan-to-Deposit Ratio Percent 450 400 350 300 250 200 150 100 50 0 a n n a a a e a a a s o a y n a a a a d a a y . a p i a i i n i i u r i r a i i i i n v i e a i i i v n n n n n s g n r b t n n g a e r a o k t t i j a a t s s o a s a e e a r g i a r o R a s e a a r o d o g e l u h o r m o d u i t u v m l n b n L k b s e S r l k e l R o k h B o u P e T h l u C i e E r o A U r B G j a l M c t e B c a A t H S i R n e z L a T z o a z A M M C K Jun-2004 Jun-2008 Source: EBRD Transition Report 2009

A unique opportunity to move on FX vulnerability and capital markets � Significant post-crisis common ground: – Large FX exposures have limited use of the exchange rate in crisis response: under-pricing fx risks at the individual level – Need to rely more on domestic sources of funding � LC market development can be a source of strength even after euro adoption. – This is thus not a detour on the way to the euro � Macro conditions becoming “local currency-friendly” � Regulatory action – albeit still uncoordinated (Hungary, Poland, Austria, etc) � With recovery underway, it is time to focus on correcting vulnerabilities

We have another collective action/coordination problem � Regulators/central banks of home and host countries: urge to act but coordination is difficult � Banks operating in the region: fear of market share loss � IFIs, EC, ECB: need for coordinated move to make the market � There is, again, a collective action and coordination problem: for banks; regulators; IFIs � Call for “Vienna Plus”

Country-by-country assessments: Different reasons - different approaches Reasons for FX Policy approach � � Improve macro policy; structural Lack of macro and institution credibility reforms � � Regulate or outright limit Moral hazard – implicit guarantee borrower exposure � � Regulate via capital and/or Externalities - lack of internalizing FX social costs prudential measures � � Develop/strengthen domestic Underdeveloped local currency markets markets (LC and forward) � � Regulate disclosure Lack of info on FX risks � � Derivatives Stock issue with credible Euro exit: manage FX volatility

“Vienna Plus”: Joint Assessments Five policy areas critical to develop local capital markets and boost domestic savings 1. Macro economic policy 2. Financial sector regulation 3. Market structure: investors, instruments, indices 4. Physical infrastructure 5. Legal and regulatory framework and enforcement

“Vienna Plus”: Identify Policies for Progress 1. Macro economic conditions : not yet stabilized; often exchange rate targeting 2. Financial sector regulations – limited basic bank prudential regulations 3. Markets/Instruments Money markets: Interbank market needs transparent reference mechanism; limited T=0 T=1 T=2 T=0 T=1 T=2 management tools (T-bills); No equity markets 4. Physical infrastructure Payments system – limited development of Identify policy and priorities that securities clearing and depositories move a country from one stage to the other 5. Legal framework and enforcement Rudimentary

Key to success � Right analysis and sequencing : – If macro credibility is the problem, address that first – If underdeveloped local currency markets: address that – If moral hazard, externalities: regulate � Involve all stakeholders – collective action problem � Keep the eye on the ball: a longer term project

“Vienna Plus” : who could do what? Governments, IMF, EC, ECB - macroeconomic policy frameworks � Governments, IMF, World Bank, EBRD - LC public debt management � European Commission - regulating FX exposures and helping with legal � frameworks Home and host regulators - develop/coordinate regulatory approaches to � FX lending EC, WB, EBRD - advising on legal/institutional changes to develop local � currency capital markets; physical infrastructure; instruments Investing IFIs (EBRD, EIB, IFC (IBRD?)) � – Issuing LC bonds – Lending in LC – Investing into market structures – Helping with derivatives markets when needed

“Vienna Plus” : who could do what? � What can banks do? – Internalizing higher credit risks of FX – lower risk thus margin on unhedged LC loans – Jointly agreeing on � a common set of lending standards � discontinuing most risky FX asset classes (short term, unsecured consumer loans) and currencies (non-Euro) – Improve disclosures and stress testing – When conditions are right, enter the long end of the LC market.

Let’s discuss! European Bank for Reconstruction and Development www.ebrd.com; www.ebrdblog.com www.ebrd.com