You're reading: East Europe banking: It’s a wild, wild ride

The past decade has been a rollercoaster of a ride for banks in Central and Eastern Europe, with Ukraine experiencing the “the sharpest ups and downs.”

These are the findings of a recent report by the world’s top business consultancy, McKinsey.

The report shows that the boom years of 2000-2007 saw a rise in the market capitalization of leading Central and Eastern European banks of 52 percent – the highest in the world – only to be followed by an equally outstanding crash of 67 percent during the next two years.

Since then many banks in the region have recovered much of the lost ground, though the group is now diverging.

Indeed, according to Raiffeissen Bank International AG, Poland, Romania and Russia are set to see loans outpace economic growth while countries such as Croatia and Ukraine will continue to pay for past excesses.

 

 

After having overcome the initial setbacks of transition, the CEE region embarked on a period of astounding growth. GDP per capita in the region grew 6 percent over 2000-2010, second only to China.

The banking sector prospered even more, as initially low levels of penetration and cheap funding from parent companies allowed for revenue growth that was three times the global average in 2000-2007, even surpassing India and China.

But while banks became bigger they didn’t necessarily become more profitable.

Indeed, according to the McKinsey report, in 2004-2007 the level of value creation, a measure showing returns on equity less the cost of obtaining capital, was a meager 0.2 percent.

This, the report warns, will remain a major problem in the future, as higher funding costs and capital requirements squeeze returns.

State interventions, like Ukraine’s ban of lending in foreign currency, add to the overall difficulty as companies will increasingly compete for new creditworthy clients. This fits in with Raiffeissen’s assessment that “loan growth in CEE will not occur in the same manner as witnessed during the past decade.”

Yet there is reason for optimism.

In addition to prospects of strong, if volatile, growth, the CEE accounts for over 40 percent of the middle class of emerging markets, despite having only 7 percent of their population. The existence of these “emerging affluents” will likely be a major driver for the banks in upcoming years.

Among the surveyed countries by McKinsey, Ukraine stands out as the economy that is the most vulnerable to external shocks, both in terms of macro and banking sector sensitivity.

“If Eastern European banking was on a rollercoaster rise in the last decade, then Ukraine saw the sharpest ups and downs,” the report’s authors claim.
One of the reasons for this volatility is an exceptionally high level of loans to deposits. In this regard, however, the situation is looking up.

Before the financial crisis Ukraine had the highest level of personal financial assets to liabilities in the world. The ratio of loans to deposits level has since fallen from over 2.2 to around 1.7, though it remains considerably above the region’s average of 1.2.

Such improvements drove the international rating agency Standard & Poor’s to change Ukraine’s banking industry from 10 (the highest risk group on a 1 to 10 scale) to 9, placing it alongside such countries as Cambodia and Venezuela. While noting slight improvements, the agency noted that economic imbalances, a poor institutional framework, and asset quality continue to hold the industry back.

Indeed, the quality of assets remains a big problem. While the general level of non-performing loans is now stabilizing and many local banks report reasonable levels of below 10 percent, the report’s authors assess that they remain at unparalleled level of around 35 percent.

In order to overcome their problems in the CEE region, the McKinsey report argues, banks should move away from models of operation based on their Western counterparts, and look toward other emerging markets. India, with its ability to adapt to low cost operations suitable for large swathes of impoverished citizens, is suggested as an inspiration.

Those unable to adapt should consider exiting the market, or limiting their offers. This is already the case in Ukraine. After Sweden’s Swedbank, which announced it would be drastically downsizing its local network, Germany’s Commerzbank is now contemplating the sale of its Ukrainian subsidiary Forum Bank.

While West European banks only account for a fifth of the market in terms of assets (compared to 70 percent in Poland), and in many ways the Ukrainian banking sector is more resilient than it was in 2008, the ride ahead may be rocky indeed.

Kyiv Post staff writer Jakub Parusinski can be reached at [email protected]