Sunday, October 12, 2008

Austria's Exposure To The East

Standard & Poor's Ratings Services has announced on Thursday that it revised its outlook on Austria-based Erste Group Bank AG to negative from stable due to the impact of increased contagion risk from global macroeconomic pressures building in Central and Eastern Europe (CEE) and Austria. At the same time, the' A/A-1' long- and short-term counterparty ratings were affirmed.

2008.10.16 08:57
Hungary, Ukraine may be downgraded by S&P

S&P has also revised to negative from stable the outlooks on Erste Bank's subsidiaries, Romania-based Banca Commerciala Romana (BCR) and Czech Republic-based Ceska Sporitelna a.s. The 'BBB-' long-term counterparty credit rating on BCR and 'A/A-1' long- and short-term counterparty ratings on Ceska were affirmed.

"The rating actions reflect growing macroeconomic risks from global financial turmoil, which might negatively affect the financial profile and business prospects in Erste Bank's major operations in the CEE region and its home country," said Standard & Poor's credit analyst Markus Schmaus.

"Furthermore, we see some contagion risk from the continued confidence crisis and increasing risk aversion, which might have a negative effect on international capital flows and investor sentiment."

“Specifically, the large operations in Romania and Hungary may put pressure on Erste Bank if the operating environment were to deteriorate further."

“Erste Bank is particularly sensitive to an economic downturn in CEE because of its strong position in the region, with average risk-weighted assets representing 42% of the group total and pre-tax profit 60% on June 30, 2008," S&P added.

“A negative rating action could occur if we observe a further rapid deterioration in macroeconomic conditions for its major operations in CEE that could potentially affect asset quality and profitability, in particular in Romania," Schmaus added.

He also noted that further pressure on the Romanian currency might be negative given the country's high level of foreign currency lending and reliance on foreign direct investments.

Austrian banks have stopped lending to domestic retail customers in foreign currencies in a move to curtail their exposure to market movements, following a strong recommendation from Austrian regulators.

The country's major banks -- including UniCredit's (CRDI.MI: Quote, Profile, Research, Stock Buzz) Bank Austria, Erste Group Bank (ERST.VI: Quote, Profile, Research, Stock Buzz) and cooperative Raiffeisen -- decided to stop forex retail lending, banks and regulators said, and smaller banks are expected to follow.

"This plea is not new, we and the central bank have warned for years about foreign currency loans," said Kurt Pribil, head of financial watchdog FMA, in an interview on Austrian radio ORF. "We have called on the banks again to rethink their policy in the face of the current crisis."

Austrian retail clients have built up 34.5 billion euros ($47.4 billion) worth of loans in foreign currencies -- almost a third of all retail loans -- since the mid-1990s, most of them mortgages held in Swiss francs .

Foreign currency loans were for a long time pushed to clients as a cheaper way to get credit by benefiting from low interest rates charged for other currencies like the franc and previously also the Japanese yen .

They pose a two-fold risk for clients. Firstly, if the loan currency rises versus the domestic currency, their debt grows. The franc hit a 4-year high against the euro last week, although it has fallen slightly since.

Secondly, those loans are typically due on maturity and backed by a repayment vehicle. Those repayment vehicles are often invested in shares along with other securities, and can fall in value if the market goes down.

"In a situation like this, where financial markets are so turbulent, this can have an impact much quicker," said Austrian central bank director Andreas Ittner, also in a radio interview.

The Austrian banks have exported foreign loans as they have moved to the emerging countries of central and eastern Europe, where they are now the biggest three lenders.

While they have not issued a blanket ban on issuing new forex loans in those countries, they have restricted lending in some, such as Hungary. In others, like Ukraine and Romania, central banks have moved to curb forex loans.

Vienna stockmarket operator Wiener Boerse said the opening auction for Austrian shares will begin at 1000 GMT. The shares had been suspended all morning amid looming price losses.

Secondary listings of Austrian stocks on the Prague Stock Exchange were also been suspended, after trading briefly in the morning.

Austria's Erste Group Bank (ERST.VI: Quote, Profile, Research, Stock Buzz) reiterated its 2008 outlook on Friday after unveiling it holds 300 million euros ($412 million) in Iceland bank debt. Its shares dropped as much as 17 percent but later pared losses.

Erste, the third-biggest lender in emerging Europe, cut its 2008 profit forecast on Tuesday, while Iceland edged towards financial meltdown over the week and the government seized control of three of the country's biggest banks.

"Obviously this is not good for investor confidence," said analyst Marion Swoboda-Brachvogel of brokerage CA Cheuvreux. "They gave a profit warning just a couple of days ago and now this. You've got to wonder, what comes next?"

Analysts' estimates varied widely regarding the level of writedown the bank would be likely to incur on its Iceland debt, ranging from 50 percent of its value to the full amount.

Erste tried to calm the waters later in the day, saying most of the possible losses from the Icelandic exposure were already reflected in Tuesday's earnings outlook, and its shares pared losses to trade down 7.4 percent by 1422 GMT.

Austria will offer unlimited guarantees on bank deposits and prohibit short selling as the government seeks to bolster confidence in the Alpine country, Chancellor Alfred Gusenbauer said today after a cabinet meeting.

``Austria's banks are secure and the deposits are secure,'' Gusenbauer said today at a press briefing in Vienna. Austria should follow German Chancellor Angela Merkel's Oct. 5 guarantee that all deposits be covered, said Gusenbauer, 48, who is preparing to leave office.

Austria's move to guarantee all deposits breaks a European Union agreement made yesterday. Finance ministers from the 15 nations using the euro agreed yesterday at a meeting to guarantee consumers' bank deposits up to 50,000 euros.

``We welcome this initiative to give additional security to savings and strengthen trust in the health of national banks,'' Raiffeisen Zentralbank Oesterreich AG Chief Executive Walter Rothensteiner said in an e-mail.

Austria's parliament will convene Oct. 28 to vote on laws restricting investors ability to speculate on falling Austrian equity values, Finance Minister Wilhelm Molterer said today.

The Austrian Traded Index, comprising the country's 20 most actively traded stocks, is down 22 percent this week and has fallen 50 percent this year. Austria's Erste Bank AG and Raiffeisen Bank International AG have led declines, dropping 34 percent and 29 percent respectively since Oct. 6.

The Czech Republic's PX Index posted its steepest drop on record, led by banks and property shares as concern deepened that the credit crisis will topple more financial companies and drag the world economy into recession.

Erste Group Bank AG, Austria's largest publicly traded lender, and developer Orco Property Group SA sank the most since their shares were listed on the exchange, which had to suspend trading in four of the 14 listed companies during trading hours.

The benchmark PX Index slid 156.1, or 15 percent, to 888.5 at the close in Prague, today's biggest fluctuation among 88 equity indexes tracked by Bloomberg. The measure lost 26 percent since Oct. 3, the worst weekly retreat on record.

``Today has written itself into history,'' said Miroslav Adamkovic, an equity analyst at Komercni Banka AS in Prague.

The PX, which gets about half of its value from Erste Bank and CEZ AS, the Czech Republic's largest power company, lost 51 percent this year on concern that $632 billion in credit-related losses at banks worldwide will help send Europe's economy into a recession.

More than $25 trillion has been erased from the value of global equities in 2008. Central banks from London and Frankfurt to Washington and Hong Kong were forced to cut interest rates after the yearlong credit-market seizure stoked concern the financial firms will run short of money.

`Bloody End'

Erste lost 153 koruna, or 22 percent, to 534 koruna, the steepest loss since the shares were listed in Prague in 2002. The bank said it has 300 million euros ($407 million) at risk in Icelandic banks.

The bourse halted trading in Erste and Vienna Insurance Group earlier in the day in line with the Vienna Stock Exchange's decision to suspend trading. The shares have their primary listing in the Austrian capital.

Orco, a developer with most of its business in the Czech Republic, fell 67.8 koruna, or 25 percent, to 207.10 koruna, the biggest decline since the shares began trading in 2005.

Komercni Banka AS, the third-largest Czech lender, dropped 541 koruna, or 15 percent, to 3,100 koruna, the steepest loss in almost nine years.

Orco Property Group SA, a central and eastern European developer whose shares have fallen 50 percent in the past week in Paris, has been hurt by the kind of short selling that has engulfed the world's banks, Chief Executive Officer Jean-Francois Ott said.

As many as 7 million of the company's 10.77 million shares have been used for short selling in recent weeks, Ott said in a phone interview yesterday from the company's headquarters in Paris, describing the decline as a ``panic sale.''

``A lot of people are doing this on our stock, and I'm really tired of it'' Ott said. ``Lehman Brothers used to be a huge short seller and they got killed by their own game.''

Orco, which is building residential and commercial projects in such countries as the Czech Republic, Slovakia and Hungary, has fallen 85 percent in the last year after missing earnings estimates. Moody's Investors Service downgraded its credit rating last month to ``Caa1,'' seven steps below investment grade as operating profit failed to materialize and the eastern European property market soured.

Short Sale

In a short sale, traders borrow stock from their brokers and sell it, profiting if the price goes down by buying it back. They return the shares to the brokers and pocket the difference.

Orco yesterday fell 82.1 koruna, or 20 percent, to 338 koruna, the lowest since it listed on the Prague stock exchange in February 2005. The company has a market value of 2.94 billion koruna ($180 million). The decline has been so rapid this week the Prague stock exchange suspended trading several times.

Orco rose 95.9 koruna, or 27 percent, to 430 koruna in Prague, the biggest gain ever, and was up 27 percent to 17.84 euros on the Paris stock exchange. In Warsaw, the shares rose 24.2 percent to 59 zloty.

The company remains financially sound, with 400 million euros ($576 million) in available cash to finance its projects over the next 12 to 24 months, Ott said.

The developer still intends to sell 200 million euros in completed projects this year and ``everything we are building right now is financed,'' he said.

Orco has no intention of changing its announced schedule of projects, he said.

The developer said in a statement to the bourse on Sept. 17 it doesn't need additional capital, and Ott said yesterday the company is spending less cash resources than it was a year ago.

Orco may follow through on a plan to buy back its shares because they trade below net asset value, but ``in today's environment we would probably reduce our bond debt instead,'' Ott said.

Orco shares closed yesterday in Paris at 14.17 euros, compared with Ott's stated net-asset value for Orco of 83.40 euros. NAV has fallen from 91.70 euros at the end of last year.

``We've been public for eight years. We have credible management. When you see your price going down like this, you take it as a very strong critique of management,'' Ott said. ``It shows there is a panic sale because the market has collapsed.''

PRAGUE, Sept 18 (Reuters) - The Prague Stock Exchange (PSE) halted trading in shares of developer Orco Property Group (ORCO.PA: Quote, Profile, Research, Stock Buzz) (ORCOsp.PR: Quote, Profile, Research, Stock Buzz) on Thursday after the stock slumped more than 20 percent from opening levels amid a global equity selloff.

According to PSE rules, at least three market makers have to agree to continue quoting the stock to restart trade. Orco shares slumped 24.1 percent to 321 crowns, versus a 3.4 percent drop for the Prague's main index.

Asutria's Banks Move East

Over the course of the last decade, Austrian banks have successfully seized the opportunity to expand their presence in the CEE banking markets. Taking into account that almost 40% of the Austrian banking system’s total profits are earned by CEE operations today, the evolution of the CEE banking markets has had a substantial influence on the Austrian banking system. With a market share of almost 24% in CEE, these operations have at the same time considerable influence on the stability of the CEE banking markets. As much as CEE subsidiaries can profit from the stability of their parent banks, they could also be affected by their potential instability. If, for example, some exogenous shock in one particular market puts an Austrian parent bank into trouble, its presence in the region could transfer this shock into other CEE markets as well. Therefore, the issues of Austrian and regional financial stability are closely interlinked. Austrian banks started to enter the CEE markets as early as in the mid- 1980s to provide service to domestic clients (Austrian industrial companies) who expanded to CEE. By the early 1990s three Austrian banking groups (or their predecessors) had established subsidiaries in neighboring countries, but also in Poland and Russia (see chart 1). During the recessions that struck most CEE countries in the 1990s, Austrian banks and their subsidiaries – contrary to many state-owned banks (SOBs) – steered clear of default, as at that time the subsidiaries were almost exclusively greenfield operations with less risky loan portfolios.

At end-2006, CEE business accounted for 20.3% of total banking assets in Austria and 38.7% of all pretax income. The overall exposure of Austrian banks in the region amounted to EUR 144.3 billion, of which EUR 52.5 billion was attributable to direct lending business and the remainder to indirect lending business via subsidiaries.

Disaggregated data on the subsidiaries of the 11 Austrian banking groups active in the region reveals that they hold considerable cumulated market shares in CEE that come to or above 40% in seven countries. For the entire region (excluding Russia and Turkey), Austrian banks’ market share reached 23.7%. Although some markets contribute significantly to Austrian banks’ overall exposure to the CEE markets – in terms of subsidiaries’ aggregate total assets, the largest exposure is vis-à-vis the Czech Republic, followed by Hungary, Croatia, Romania and Slovakia – it is well diversified with no single country contributing more than 20%.

Loan growth, however, continues to be a concern from the supervisory perspective. The total loan growth of the median bank in the region was 22.4% in 2005, which raised fears that part of this growth comes at the cost of accumulating hidden credit risk (see Hilbers et al., 2005). Lending to private households grew considerably faster over the last years. Given the current level of intermediation depth, growth rates reflect a catching-up process to EU-15 levels (see ECB, 2006, or Backé and Walko, 2006). The speed of this process, however, is challenging for individual banks and for policymakers. A par-ticular concern in the region is foreign currency lending, which exposes the borrowers (households and corporations) to exchange rate risk, which may materialize in the form of (indirect) credit risk in banks’ loan portfolios, and also entails reputation risk for heavily involved banks (see ECB, 2006).

In this study, we look at the three most important financial channels, two of them being direct and one indirect. The first direct channel relates to a plunge in the prices of financial assets in the portfolio of CESEE financial institutions, while the second direct channel reflects the deteriorating investor sentiment toward emerging markets in general and CESEE in particular (“portfolio investor view”), manifesting itself in an increase in risk premiums and/or a decline in, or a sudden stop of, net capital inflows into the region (mainly in CESEE countries with a substantial stock of foreign portfolio investments). Moving on to possible indirect financial channels, the third channel relates to a situation in which the CESEE region is hit, first and foremost, by a severe tightening of global credit conditions that affects the region’s major creditors (“strategic investor view”) and leads to a slowdown in (or, in the worst case, to a sudden stop of) capital inflows and, subsequently, to an increase in liquidity constraints.

Austria's economy is doing well, and one of the building blocks of its economic success is the banking sector, which has been expanding rapidly in central, eastern, and southeastern Europe (CESE).

This process has been highly profitable and has helped financial deepening in the region. It is, however, not without risk. Therefore, it needs to be accompanied by a strong focus on risk management by the banks and effective cross-border cooperation between supervisors in Austria and CESE.

Economic growth in Austria has consistently exceeded that in the euro area in recent years, and unemployment has declined. A number of factors help explain Austria's success. The government's macroeconomic policies have ensured stability, structural reforms have improved the functioning of the economy, and a social partnership has helped keep wages in check.

In addition, Austria's private sector has sought out new business opportunities in fast-growing markets located in CESE. Austria's growing relations with the countries in this region are based not only on increased trade and investment but also on stronger financial ties, made possible by the expansion of Austrian banks.

A bit of history

Driven by geographical proximity, historical ties, and a saturated domestic market, Austrian banks were among the first to enter the new markets in central and eastern Europe in the early 1990s. During 2003-05, they gained market share in almost all of the CESE countries (see Chart 1). Today, they are active in virtually all countries in the region.

Even though Austrian banks are not large by international standards, their subsidiaries are large in relation to the size of the economies in CESE. These subsidiaries have also become important to Austria's own banking system because they constitute a significant share of the banks' total assets and generate a large portion of the profits.

Austria's exposure to the CESE countries is far larger (relative to GDP) than that of its European peers (see Chart 2). In 2005, the total assets of the five largest Austrian banks in CESE amounted to about 16 percent of total assets—mostly in the form of majority-owned subsidiaries—and Austrian banks derived some 35 percent of their pretax profits from the region.

The profitability of the operations in CESE is driven by rapid credit growth. To a large extent, this reflects the financial market development and deepening that is to be expected in countries that are catching up with western Europe. But the high growth rate of private sector credit has made it more difficult to assess credit risk. It has also, in cases, contributed to macroeconomic imbalances in the form of large current account deficits.

Profitable, but not without risk

So far, the rapid credit growth in the CESE countries has been good for business because the strong demand for credit has enabled the banks to lend at relatively large margins. But the operating margins may come under strain in the next few years as financial markets there develop further, and credit growth may start to slow.

Moreover, the development of financial markets may affect profits more directly by increasing competition, thereby narrowing margins. In fact, some of these factors are already resulting in a downward trend for the interest rate margins of banks operating in CESE countries

Operations in CESE countries entail a number of other risks as well. Various countries in the region exhibit macroeconomic imbalances. Although such imbalances reflect, to a certain extent, the catch-up process with living standards in western Europe, they are considerable in some cases, and there is a risk that they could have a negative impact on investor sentiment.

Banks operating in the region also have to cope with significant exchange rate volatility, and they are finding it difficult to enforce proper credit risk standards in an environment with rapid credit growth, partial or nonexistent credit histories, legal risks, and limited experience in credit screening. Good credit assessment skills and effective internal controls and corporate governance structures are essential to effective risk management.

Lending in foreign exchange to households adds to the banks' risks. This practice is prevalent in both Austria and the CESE countries. Domestically, foreign exchange credit—denominated mostly in Swiss francs—is monitored, and Austrian supervisors do their best to educate consumers about the risks of borrowing in foreign currency.

But in the CESE countries, monitoring of foreign exchange credits is less well developed, and consumers are presumably less aware of the risks involved. Although banks generally apply prudent lending standards to foreign exchange credits, large exchange rate movements may result in the foreign exchange risks of households translating into credit risks for the banks.

What supervisors should do

The challenges for Austria's banking supervisors are closely related to the challenges faced by the banks themselves. First, the rapidly expanding activities of the financial sector require close monitoring, and supervisors need to ensure that the banks use adequate risk management and measurement techniques. The banks should pay special attention to the issue of intragroup risk and capital transfers and should also assess the macroprudential risks associated with the macroeconomic imbalances in some CESE countries. This requires, among other things, regular stress testing of the systems.

Second, close collaboration between Austria's supervisors and those of the host countries will be key to effective supervision of cross-border banking groups. The enlargement of the European Union (EU) has facilitated cross-border supervisory cooperation with the new member states, including through the signing of memoranda of understanding (MoUs) between home and host supervisors, which facilitate the exchange of information and cooperation.

Such cooperation will need to intensify, and cross-border supervisory cooperation with non-EU member states in which the Austrian financial sector has a significant market share should be deepened.

Austria's supervisory authorities have already devoted considerable attention to risk management and home-host supervisory issues. They have stepped up their on-site inspections and intensified off-site examinations of systemically important banks. They have also signed a large number of MoUs on supervisory cooperation and are involved in a dialogue with foreign supervisors with whom no MoUs have yet been signed.

The authorities are increasingly involving their foreign peers in risk assessments and are performing some joint inspections of the cross-border activities of Austrian banks, and they are taking steps to further strengthen corporate governance in the banking sector.

The bottom line

Austrian banks' exposure to CESE countries is large and keeps increasing. Austrian banks now own a major part of the domestic banking system in many countries in the region and derive a large share of their profits from those countries. Banks' risk measurement and management must keep pace with their international expansion, including with regard to the special risks involved in lending in foreign exchange.

The Austrian supervisors are aware of the need to ensure that banks use adequate risk control techniques and are already cooperating closely with their counterparts in the CESE countries. Further cooperation will be essential to ensure the effective supervision of cross-border banking groups.

Low profitability domestically (price competition, strong focus on business volume), geographical proximity and historical ties, as well as above-average growth and profit potential, were key reasons for Austrian banks pioneering role in investing in Central and Eastern Europe. According to estimates of the Oesterreichische Nationalbank (OeNB), some 22% of the total assets of Central and Eastern European banks (excluding Russia) are currently held by Austrian banking groups (including Bank Austria Creditanstalt — BA-CA). This means Austrian banks are the biggest investors (well ahead of Italy and Belgium) in the Central and Eastern European banking sector. Erste Bank, BA-CA and Raiffeisen Zentralbank (RZB) are among the most active Western European banks operating in the CEE region.2 Erste Bank, via its subsidiaries, is one of the biggest players in the Czech Republic (C´ eska« spor´itelna), the Slovak Republic (Slovenska« sporiteln´a), Croatia (Rijecka banka) and — now through its acquisition of Postabank — also in Hungary. BA-CA, via its subsidiaries, holds a significant slice of the market in Poland (Bank BPH), Croatia (Splitska banka) and Bulgaria (Biochim) and is also represented by subsidiaries in seven other CEE countries.

RZB has a very well-known brand name in CEE countries and controls a significant share of the market in the Slovak Republic (Tatra banka), Croatia, Serbia, Romania, Bosnia and Herzegovina, and Albania. With subsidiaries in 15 countries, RZB has the most extensive marketing network of all Western European banks represented in Eastern Europe. Major CEE operations are also run by O‹ VAG (subsidiaries in eight CEE countries), Hypo Alpe-Adria Bank (HAAB, primarily in Croatia) and BAWAG (Slovak Republic, Czech Republic, Hungary).


The total assets of banks operating in Hungary are about EUR 51 billion. At the end of 2003, 218 banks were registered in the country. Most of these banks (about 180) are small cooperative banks, which are of minor importance overall (market share: some 7%).6 At about 69%, the degree of bank intermediation in Hungary is somewhat below the CEE average (74%), and the degree of concentration (market share of the five largest banks) is around 57%. Foreign banks also play a leading role in Hungary. Following the privatization of Postabank and Konzumbank, approximately 82% of Hungarian bank assets are now controlled by foreign banks. However, OTP — the biggest Hungarian bank by far — remains independent and is almost entirely privately owned.7 In the past few years the Hungarian banking market has witnessed a dramatic growth in lending (according to the PSZAF, private sector lending grew by 66% in 2003). Growth was driven by the introduction of government subsidies for housing finance in 2001. Banking industry representatives estimate that government subsidies for home loans account for some 70% of private households demand for government-subsidized home loans. This makes Hungary the sole CEE country in which earnings from home loans make a significant contribution to the total income of the banking sector.8 Budgetary problems (the running costs of the scheme amounted to around 1% of GDP) led to a sharp retrenchment in state subsidies for home loans. As this measure was expected months in advance, it met with a response anticipating the change. As a result, demand for subsidized home loans continued to grow in 2003. Lending to wholesale customers and foreign groups is bitterly contested and marked by falling margins. Hungarys small and medium-sized enterprises (SMEs) still find it hard to obtain bank loans.

For 2004, growth in personal loans is expected to flag significantly owing to the amended terms of home loan subsidies and to the increase in domestic interest rates. Hungarian banks are currently seeking to boost demand for consumer lending by launching new products such as foreign currency loans. Increasing the demand for foreign currency loans — particularly by private households — could lead to risks arising for the Hungarian banking sector. The Hungarian banking sector is adequately capitalized (average solvency ratio: 12.0%) and has been very profitable in the past few years (2003 ROA before tax: approximately 1.8%).

As already mentioned, OTP (total assets: some EUR 11 billion) is by far the leading bank in Hungary. It is one of the biggest and most profitable banks in the CEE region and, in recent years, has also acquired banks in the Slovak Republic and in Bulgaria (OTP beat Erste Bank in the bidding race for a Bulgarian bank, DSK). Hungary s second-largest bank is K&H bank (controlled by the Belgian KBC and the Dutch ANB-Amro). MKB is dominated by Bayerische Landesbank (BAWAG has a minority interest), CIB by the Italian Intesa. The acquisition of Postabank in October 2003 (purchasing price: EUR 400 million) allowed Erste Bank to increase its market share substantially. Including Postabank, Erste Banks market share is approximately 8%.

Austrian Banks Control around 20% of the Hungarian Banking Market

Seven Austrian banks currently operate in Hungary. The market share of Austrian banks is about 20% overall (including Postabank). Following its acquisition of Postabank, Erste Bank is now the biggest Austrian bank in Hungary (the fifth largest in the country with a market share of some 8%). Raiffeisen Bank Ungarn managed to overtake HVB Bank Ungarn this year and is now just ahead of the latter as the countrys sixth-largest bank (market share: approximately 6%). Extensive banking operations are also carried out by Volksbank and Porschebank in Hungary. Bank Burgenland, which only recently established a subsidiary in Sopron, and the bank Samesch & Cie AG are represented by extremely small operations in the Hungarian market (total assets of both banks: less than EUR 12 million). Excluding Volksbank, all major Austrian banks in Hungary generate far higher returns than in their domestic market. In May 2004 a consortium consisting ofWiener Bo‹rse (the Vienna stock exchange) and Austrias major banks acquired the majority of shares in the Budapest stock exchange. In 2003 RZBs subsidiary was the most successful Austrian bank in Hungary. Raiffeisen Bank Ungarn generated not only strong lending growth but also exceptionally high return on equity (ROE: 27.5%). The profitability of the BA-CA and Erste Bank subsidiaries was roughly around the Hungarian average. By contrast, the profitability of the Volksbank subsidiary was poor.

Czech Republic

With total assets of some EUR 80 billion, the Czech banking market is the second largest in the CEE region. The ratio of total assets to GDP shows that the Czech economy has a far higher degree of bank intermediation (105%) than other CEE countries (except five largest banks) similarly exceeds the CEE average.9 The countrys biggest banks are without exception owned by Western European banking groups. The share of foreign bank assets as a percentage of total Czech bank assets is estimated to be about 90%. Following the banking crisis of 1999—2000 and the subsequent estab- for Croatia). At 66%, the degree of concentration (market share of the lishment of the government consolidation
agency CCA, the big stateowned
banks were successfully sold
to foreign banking groups in 2000.
Ample guarantees provided by the
CCA were crucial to the success of
the privatization. For instance, foreign
banking groups were granted the right
of transferring to the CCA within a
two-year period loans that were in
poor rating categories at the time of
takeover (ringfence agreement).
As early as 2002 and 2003, the
Czech banking sector generated renewed
high profits (according to the
Czech central bank, ROA after tax
was 1.2% in 2003). Furthermore, it
also boasted extremely healthy capital
adequacy of 14.4% (preliminary figure
for 2003).
The transfer of NPLs to the CCA
resulted in a sharp reduction in total
lending in 2002 in particular. This,
in turn, also led to an improvement
in the quality of the loan portfolio
(with the NPL ratio falling from
19.4% to 9.4%). 2003 saw the collapse
of two small banks (Union
banka, Plzeo‘ ska« banka), which did
not, however, have an impact on the stability of the countrys financial market.
Czech banks continue to steer a
very tight personal loans policy. The
balance sheets of major Czech banks
tend to be excessively liquid (deposits
being far higher than total loans). The
share of domestic personal loans as a
percentage of GDP is one of the
lowest in the region as a whole.10 A
large proportion of deposits are still
invested in low-yield government
bonds. The aim over the next few
years will be to redirect funds from
government bonds to personal loans.
In order to bolster the confidence of
private sector banks, the C´ NB established
a Major Loans Register in November
2002. In addition, a government-
subsidized home loan scheme
was launched.
PreliminaryC´ NB figures for 2003
indicate a recovery in demand for
loans — particularly by private households.
Whereas lending to enterprises
stagnated at 2002 levels, loans to
private households grew steeply
(+35%), albeit from a low base.
Overall, lending to nonbanks in
2003 expanded by around 11%.

The Czech banking sector is dominated by three banks. With the takeover of IPB (a major bank on the verge of collapse in June 2000), CSOB became the market leader (market share: 21%). CSOB is 82%-owned by the Belgian KBC. The second-largest bank in the country isC´ eska« spor´itelna, the formerly state-owned savings bank (market share: 19%), of which the majority shareholder (98%) is Erste Bank. Closely following C´ eska« spor´itelna is Komere‘nıç banka, which is controlled by the French Socie«te« Ge«ne «rale (stake: 60%). Next, albeit trailing by a long margin, come the Czech BA-CA subsidiary, HVB-Bank and the Czech subsidiary of Commerzbank.

Market Share of Austrian Banks —
Around 30%
Five Austrian banks are currently represented
by their own subsidiaries in
the Czech banking market, accounting
for roughly 30% of total assets.
By far the biggest and most profitable
bank is C´ eska« spor´itelna, Erste
Banks subsidiary. With an ROE of
23.7% (2003), the Czech subsidiary
is also of crucial importance to the
profitability of the entire Erste Bank
group. In 2003,C´ eska« spor´itelna generated
around 35% of Erste Banks
consolidated income.
HVB is the fourth-largest bank in
the country, specializing specifically
in corporate banking and leasing finance.
With an ROE of 11.6%, the
subsidiarys profitability is relatively

Although RZB sharply boosted the
profits of its subsidiary, Raiffeisenbank
a.s., in 2003, the latters profitability
(ROE: 12.1%) lagged behind the market
average. The Raiffeisen group also
operates Raiffeisen Stavebni sporitelna,
a home loans specialist in the
Czech Republic.
Volksbank operates Volksbank
Prag, a small operation, which has
nevertheless expanded considerably
in the last few years. It was founded
in 1993 and focuses primarily on
SMEs and infrastructure finance.
Since the takeover of Interbanka in
September 2003 (the shares were
bought by Bayerische Landesbank),
BAWAG has also been active in the
Czech banking market.

Austria's finance ministry is considering taking an equity stake in public sector financier Kommunalkredit [KKAT.UL] to improve the lender's rating, a ministry spokesman said on Tuesday. Talks were proceeding about how big such a stake could be and what form of equity would be injected in the bank, which faces a liquidity squeeze because it relies on wholesale funding to refinance its loan book, the spokesman said.

"We are thinking about how we can put their business model on a sustainable foundation," Harald Waiglein said.

"Of course we are also talking about capital measures, because this would help improve the rating, which then would also improve the earnings situation," said the spokesman.

Kommunalkredit said on Sunday it had started talks with the finance ministry about measures under the country's recently enacted banking stability package.

Kommunalkredit, a key financier of Austrian states and municipalities that has 20 billion euros ($25 billion) in bonds outstanding, is the first major Austrian bank to require state help arising from the global financial crisis.

The unlisted bank has a balance sheet total of 34.5 billion euros, making it Austria's eighth-biggest lender.

With only 3 percent of its assets in customer deposits, it is highly dependent on wholesale refinancing, a market that has practically dried up.

"The problem is that their business model has come under pressure," Waiglein said. "They are refinancing on the interbank or bond market, and both those markets don't function."

Waiglein confirmed media reports saying that Kommunalkredit was also exposed to Icelandic bank debt, but added that this was not the reason for its current problems. He declined to say how big its Icelandic exposure was.

According to the Bank for International Settlements, Austrian banks are owed 2.6 billion euros by Icelandic borrowers, a high exposure relative to Austria's size. Media reports have put Kommunalkredit's exposure at 200 million euros.

The Austrian parliament last week approved a 100 billion euro package to shield its financial sector. The plan, mirroring similar deals by other European countries, includes measures to boost banks' liquidity as well as inject capital. [ID:nLG634516]

The government brokered a private-sector bailout of small Constantia Privatbank last week. [ID:nLH274326]

Kommunalkredit is majority-owned by Austrian cooperative Volksbanken AG (OTVVp.VI: Quote, Profile, Research, Stock Buzz), while 49 percent belongs to Belgium's Dexia (DEXI.BR: Quote, Profile, Research, Stock Buzz), a bank that received support from the French, Belgian and Luxembourg governments earlier this month. (Writing by Boris Groendahl, editing by Will Waterman)

Austria's move to help its banks with state funds is less aimed at shoring up troubled lenders and more at boosting credit and growth in emerging Europe, where its banks dominate and it could lose heavily from a downturn.

The Austrian financial sector's lucrative grip on the former Communist part of Europe, which contributed 42 percent of its profits last year, has turned into a risk. It has even made it relatively more expensive for the government to borrow and has driven up costs to insure against its default in recent months.

Austrian banks are owed $290 billion by borrowers from Albania to Russia. Its exposure is much higher than that of Italy, Germany and France, and almost on par with what Spain has lent to Latin America, according to the Bank for International Settlements.

Relative to the size of the Alpine country, the exposure -- roughly equal to its gross domestic product -- is daunting.

In other words: should the recent central European hiccup turn into a crisis of Asian or Latin American proportions, with currencies devaluing and debtors defaulting en masse, Austria would be in trouble, and more so than any other western country.

This fact has shaped how the Austrian government is using its 100 billion euro ($129 billion) banking package.

The finance ministry last week agreed to boost the capital of Erste Group Bank by 2.7 billion euros, even though the bank, emerging Europe's third-biggest lender, is well-capitalized and funded.

The state money came cheaper and with fewer strings attached than similar deals in Germany or Belgium. There are few rules on how to use the capital -- just enough to allow the government to present the measure as boosting domestic credit.

In reality, most of the capital is going to underpin lending in countries including Romania, where Erste owns the biggest bank, or Hungary, where it is number 6.

"That this is about providing credit to Austrian companies is just a pretense," said Matthias Siller, who manages emerging market funds at Baring Asset Management. "This move is a clear commitment to eastern Europe.

"But this has nothing to do with charity. Those (Austrian) banks are system-relevant banks in central and Eastern Europe, and if they had to withdraw capital from there, this would set off a landslide," he said.


Several emerging countries in Europe share the problem of a gaping hole in their current accounts which they currently fill to a large extent through the funding that Austrian, Italian, French, Belgian and Swedish parent banks provide.

Fears that they were about to choke off lending because the parents themselves had trouble refinancing played a big role when investors dumped Hungarian assets in droves last month.

Under pressure from the Hungarian central bank, the foreign parents had to pledge publicly to continue to grant credit to Hungarian clients to help calm the markets.

By tapping their home governments, the banks effectively lean on taxpayers in their home countries for refinancing countries with large current account imbalances -- which also include Romania, Bulgaria and the Baltics.

"Given the expansion of the Austrian banking system into central and Eastern Europe, (the Austrian government is) implicitly providing a 'vendor-financing' deal," said Ian Harnett of Absolute Strategy Research.

"The banks are simply passing their financing problems onto the public sector," he said.

By accepting the state money Erste ended a game of chicken in which every Austrian bank appeared to fear the embarrassment of being the first to ask for some of the 15 billion euros Austria has set aside for capital measures.

As it turned out, the market loved the deal, and Erste's shares have gained 17 percent since.

That reaction makes it a likely blueprint for other Austrian banks, such as Raiffeisen Zentralbank (RZB), whose Raiffeisen International arm is the second-biggest lender in the region, and even UniCredit's Bank Austria, the No.1.

However, some analysts doubt it will be enough to rely on small, disproportionally affected countries to shoulder the risk if things begin to head downwards on a bigger scale in emerging Europe.

"If there is no EU-wide plan then it will be left to Sweden (in the Baltics) and Austria (on the Balkans) to take care of this," said Lars Christensen, an analyst at Danske Bank.

"Obviously you can't have the Austrian government bailing out central and Eastern Europe," he added. "The problem in this situation is a lack of coordination between European Union governments about a stabilization plan for Eastern Europe."