Improved sentiment towards the Eurozone is lessening the risks to Emerging European banks from the withdrawal of parent group funding and external credit conditions, according to a new report by Capital Economics. However, rising non-performing loans and low profitability is likely to keep the region's lenders weak, subduing wider economic growth, it claims. Turkey is an exception - but right now Ankara needs to see strong lending growth like it needs a hole in the head.
Due to the high level of ownership by Eurozone banks in much of Central Europe and the Balkans, the banking sector has long been seen as one of the most likely contagion routes for the debt crisis into the region. The warnings of cuts in funding, or even reverse capital flows in some quarters, have come thick and fast. The worst has been averted thus far according to most reports, which maintain that the trend has remained limited, although some countries - Hungary and some Balkan markets - have been more affected.
However, against a backdrop of European Central Bank moves to provide liquidity and receding fears of any new shocks in the Eurozone sector, the analysts note that while parent banks appear to have continued to withdraw funding from the region in recent months, the pace of withdrawals has eased.
Meanwhile, while Turkey has less Eurozone ownership, its banks are heavily reliant on external borrowing from European lenders. But the improving sentiment in the single-currency bloc is now seeing an easing in financing conditions for banks dependent on wholesale funding, Capital Economics reports. "This is particularly the case in Turkey, where banks have become reliant on short-term external borrowing to finance lending," they note. "In recent months, net inflows to both Turkish and Russian banks have increased."
The heat is on
Yet we're not out of the woods by a long shot, the analysts warn in their latest Emerging Europe Banking Heat Map. "Looking ahead, a renewed escalation in the crisis in the euro-zone would pose a significant threat to banks in Emerging Europe. But even if this is avoided, banking systems in large parts of the region will remain weak ... [N]on-performing loans have edged up in most of Central and South Eastern Europe. In aggregate at least, capital buffers remain high in most places. But a combination of rising [non-performing loans] and low bank profitability will keep credit conditions tight across most of the region, and is another reason to expect economic growth to remain subdued."
Unsurprisingly, Hungary appears most at risk. Budapest's rough handling of the country's banks, which have been hit several times with new taxes and programmes to make them shoulder losses on foreign exchange loans to retail customers, has seen them pull funding and lending.
Therefore, Capital Economics points out that unpredictable policy towards the financial sector is still adding to the headwinds facing banks, and forecasts that credit conditions will remain tightest in Hungary out of the whole region. However, "lending will also remain weak in Bulgaria, Croatia, Romania and even Poland (where a period of strong credit growth has seen household savings rates drop to near-record lows)," the report predicts. "The Czech banking system remains the most stable in the region, but even here banks have become reluctant to lend."
In line with Murphy's law, the one country in the region likely to escape expectations of continued weak lending is that which spent 2012 desperately trying to brake credit growth. "Fresh inflows of capital to Turkish banks have raised the prospect of a renewed acceleration in credit growth. This should support economic growth in the first half of the year," Capital Economics admits.
However, Turkey's success last year was to reduce the wild lending growth that helped push the economy to 8.5% expansion in 2011. Ankara has worked hard at achieving a "soft landing," in a bid to reduce a huge current account deficit that, ironically, exposes it too heavily to Eurozone banks for comfort.
The country was rewarded in late 2012 with its first investment grade rating in close to 20 years, when Fitch Ratings upgraded it on the back of its dropping trade deficit and inflation. "[G]iven the country's large current account deficit and banks' already hefty external debt burden," Capital Economics notes, "a renewed spike in credit growth could ultimately prove to be destabilising."
Indeed, the Central Bank of Turkey (CBT) is already juggling policy in a bid to stem retail credit growth without knocking wider economic expansion. That stance will only be extended by any slackening in credit conditions, as well as inflation reported well above consensus expectations at 7.3% on February 4. "We anticipate further macro prudential tinkering," write analysts at RBS. "We expect private sector credit growth to exceed the 15% [year on year] estimate of the CBT, as local banks reduce some of their exposure to government bonds and increase lending to the real economy."