CEE banks – at a high-water mark?

For many years after the financial crisis, Raiffeisen Bank International’s annual summer report on the banking landscape of central and eastern Europe made for fairly dismal reading.

The gloom has gradually lifted, as restructuring and economic recovery have brought relief from the post-2009 pain. But the exuberance of this year’s report is unparalleled in recent years.

RBI’s analysts sound almost giddy with excitement as they catalogue the remarkable performance of banks across the region in 2018. Most metrics hit multi-year highs – or lows, in the case of non-performing loan (NPL) ratios. Several were back to pre-Lehman levels.

For the first time since 2008, none of the 14 markets covered by RBI was loss-making on aggregate. Total banking profits from central and southeastern Europe reached close to €14 billion, well above the highs of the early 2000s. Overall, return on equity for the region topped 12%.

As the RBI team note, this partly reflects the fact that a protracted sector-wide balance sheet clean-up is finally coming to an end. The overall NPL ratio for CEE fell to 7.7% last year, the lowest level since 2010.

Big mover

For the fourth successive year, the biggest decline was in southeastern Europe, the sub-region that bore the brunt of the post-financial crisis correction. As recently as December 2014, NPLs accounted for 19.5% of loans there. By the start of this year, that had fallen to 7%.

SEE was also the big mover in credit growth, matching the boom markets of central Europe last year with a rise of around 7% in outstanding loans in local currency terms. In terms of return on equity, it overtook its central European peers for the first time ever, posting a regional record of 12.8%.

Eastern Europe also put in a solid performance. Russia, Ukraine and Belarus all saw double-digit credit growth, while return on equity for the region jumped to 12.7%.

Faced with all this good news, it seems churlish to accentuate the negative. At the same time, the convergence of a clutch of worrying trends suggests that last year’s outperformance could represent a high-water mark for CEE’s banks.

First and most obvious of these is a forecast decline in recent robust regional economic growth. Last year, six of the 14 countries covered by Raiffeisen posted GDP growth of more than 4%. This year only three – Poland, Hungary and Kosovo – are expected to do so.

For 2020, the forecast is even less buoyant – just five economies are tipped to grow by 3% or more. None is expected to reach 4%.

If that fails to put a dampener on credit growth, regulators in the region have increasingly shown that they are happy to step in. That is because, across most of the region, the recent lending boom has been primarily retail-driven.

Last year, the increase in lending to households was significantly higherthan that to corporates in 10 of RBI’s 14 markets. The one notable exception was Hungary, where the household loan stock grew by just 6% compared with 15% for the corporate segment – a legacy of painful post-crisis retail deleveraging.

Red flags

Unsurprisingly, this retail bonanza has raised red flags for local policymakers. Over the past 18 months, measures to curb overindebtedness – in the form of limits on debt-to-income ratios and loan-to-value mortgages – have been introduced in Czech Republic, Slovakia, Romania, Croatia, Serbia and Russia.

At the same time, regulators in the region’s EU member states are showing increasing enthusiasm for the European Systemic Risk Board’s countercyclical capital buffer. The Czech Republic and Slovakia raised their buffer rates in May and June respectively, while Bulgaria’s will come into force in October.

Still more worrying is the proliferation of bank taxes, or their near-equivalent, in CESEE. Romania’s originally punitive levy, announced in late December, has been watered down to more manageable levels but will still take some of the gloss off recovering bank profits.

Meanwhile, in the Czech Republic, the foreign banks that dominate the sector are putting a positive spin on the decision by Andrej Babis’s government to request “voluntary” contributions to a national development fund rather than opting for a full-blown bank tax.

The theory is that a one-off payment will be less painful than a recurring levy. But the fact is that a principle has been established – that foreign banks aren’t entitled to take all their profits out of the country – and a precedent has been set.

This matters because the Czech Republic has been the largest and most stable generator of bank profits in CEE over the past decade. Since 2009, sector return on equity has never dipped below 16%. Last year’s figure came in at 17.6%.  

The biggest players in the country have relied on their subsidiaries for a sizeable chunk of group profits in an unstable era. At one point, Komercni Banka was contributing more than 25% of SocGen’s net income. Ceska Sporitelna accounted for 45% of Erste’s pre-tax CEE bottom line last year.

If Czech Republic loses its lustre, the return of growth of SEE will be only partial comfort. For one thing, the region’s markets are a lot smaller. RBI analysts put the aggregated banking balance sheet in central Europe at €900 million, more than three times the €270 million in SEE.

More importantly, as has been amply demonstrated over the last decade, Romania and the Balkans remain firmly in emerging market territory in terms of volatility. The same obviously also applies to the former Soviet states of eastern Europe.

If banking in the Czech Republic becomes less profitable; if the slowdown in GDP growth across CEE continues; if regional regulators take a firmer line on retail lending; if politicians prove unable to resist repeated raids on bank profits; if volatility returns to key markets such as Russia and Romania…

If all or any of these come to pass, future RBI banking sector reports may not make for quite such feel-good summer reading.

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