World Bank Conference The Financial Sector Post-Crisis: Challenges and Vulnerabilities

1. Eastern Europe, Russia and Central Asia World Bank ConferenceThe Financial Sector Post-Crisis: Challenges and Vulnerabilities Scott Bugie Managing Director, Financial Services Ratings +33 (0)1.44.20.66.80 scott_bugie@standardandpoors.com Washington, D.C. April 26, 2005

2. Global View of Emerging Market Banks • Broadly speaking, macroeconomic environment and sectoral infrastructure have improved • Likelihood of future bankingcrises has receded • Certain banking systems remain vulnerable • Key question: Is the improvement secular or cyclical?

3. FDI and Reduced Corporate Leverage Drive Improvement in Credit Profile of EM Banks • Foreign Direct Investment • Accelerated banking and securities reforms • Brought much-needed banking know-how and capital • Deepened globalization of world financial sector • Promoted spread of best practices in bank supervision and risk management (although much work remains) • Reduced Coporate Leverage • Asian corporates hit by 1997-1998 crisis deleveraged over past several years and reduced industrial overcapacity (that led to crisis) • Certain governments set up SPVs to purchase bad assets from troubled banks to facilitate restructuring • Mexico, Turkey, and Brazil have lower levels of debt to GDP in 2004 than at the end of the 1990s

4. Global Ranking of Emerging Market Banking Systems by Industry and Economic Risk * For comparison purposes; Standard & Poor’s classifies these countries as mature markets

5. Over Past Five Years, Russian Bank CreditworthinessLagsSovereign

6. Russian Banking Market Turbulence inSummer 2004Underlying Causes • Low confidence of households and corporates in Russian banks • Interbank and Veksel (promissory notes) markets highly segmented, volatile, shallow • Prevalence of Financial Industrial Groups (FIGs) maintains mistrust • Mismatch between long-term assets and short-term liabilities • Concentrations in funding • Downturn in Russian securities markets (starting April ’04) • CBR’s policy to clean-up banking sector, with policy of withdrawing licenses

7. Russian Bank FailuresMay – August 2004 * Operations suspended in July 2004, but license not withdrawn

8. Russian Retail Deposit Growth in 2004 Retail deposits approximately $70 billion at year-end 2004 Source: Central Bank of Russia

9. Russian Credit Growth Continues Through Market Turbulence At year-end 2004, total loans of Russian banks totalled approx. $140b, of which retail loans $21b and loans to banks $10b Personal loans doubled in 2004 Source: Central Bank of Russia

10. Russian Banking Industry Effective measures and policies • Tax reform has contributed to the economic boom • Reform of securities markets underpins bank business and funding • Bank deposit insurance step in right direction • Reduction in reserve requirements boosts intermediation Remaining vulnerabilities/challenges • Dominance of state banks Sberbank and VTB distorts market and holds back its development • Limited economies of scale for private sector banks • Continued lack of confidence (e.g. banking market panic in 2004) • High single-party and related party concentrations create risks • Arbitrary legal environment undermines creditor rights • Opaque ownership perpetuates lack of trust

11. Russian Banking Sector Likely toConsolidate in Medium-term • Over 1,250 banks • No single private sector bank has a market share of more than 6% • Deposit insurance scheme may lead to exit of marginal banks Recent M&A activity: Nikoil/Avtobank/UralSib; Rosbank/OVK; VTB/Guta; VTB/Promstroi Key question: will FDI increase?

12. Restructuring of Turkish Banking SectorComparison with Russia At beginning of 2000, Turkish financial sector had many similarities with Russian sector of 2005: • Turkish state banks held important position, particularly in retail market • State banks (particularly Ziraat and Halk) unfair competitors for deposits • Banks relied on trading profits • Several large FIGs with strong position in banking market (e.g. Sabançi, Cukurova, Dogus, Is, Koç) • Engrained practice of intragroup lending in FIGs • Banks profited from large equity holdings • Low level of publicly-disclosed nonperforming loans • Many marginal banks with weak franchises • Ineffective banking supervision

13. Restructuring of Turkish Banking SectorComparison with Russia But a few key differences of Turkish banking sector Russia at the beginning of 2000: • Turkish state banks had weak financial profiles, in contrast to Sberbank and VTB • Unlike Russian state banks, Turkish state banks distributed massive subsidies in agricultural, small business, real estate sectors • Many Turkish private sector banks had deeper experience, longer track record, better franchises than today’s Russian private sector banks • Turkey had many fewer banks (79) than Russia

14. Massive Restructuring of Turkish Banking Sector in Past Four Years • New regulatory authority created, new banking law adopted • Massive supervisory action – Regulators took over weak banks representing 25% of sector (e.g. Pamukbank, Demirbank Iktisat, Esbank, Ticaret, Interbank, Imar Bank) • Special audit for all private banks, with stricter rules on reporting problem loans, stricter enforcement of limits on intragroup loans and single party concentrations • Number of banks reduced to 50 from 79 • Government guaranteed all retail deposits (partially withdrawn this year) • Loan subsidies were shifted from state banks directly to government • State banks recapitalized and downsized • State RE bank Emlak closed, assets transferred to Ziraat and Halk • FDI is starting to build (Fortis/Disbank) Total cost of restructuring: est. $40-50 billion, or 30% of Turkish GDP

15. Lessons from Turkey • Clean-up of banking sector costly if problems left unattended many years • Strong, persistent regulatory actions required to break ingrained habits • Level of problem loans during an expansion is poor indicator of potential extent of problems in recession • True extent of intragroup lending difficult to assess • Intragroup exposures increase in downturn

16. Systemwide Nonperforming Loans in Turkey Peaked at 25% of Total Loans in 2001 Up from 3.5% in 1998 peak of 25% at yearend 2001 Source: Central Bank of Turkey

17. Banking Sector Undevelopped in EEMEADomestic Credit to Private Sector to GDP Source: Standard & Poor’s Data as of year-end 2003

18. Domestic Credit to Private Sector to GDPPotential for Growth in EEMEA and LA

19. Mortgage Lending in Emerging Markets Remains Undevelopped

20. Polish Banking Industry • Effective measures and policies • Convergence of regulatory environment with EU • Improvements in regulatory policy concerning problem loans (notably statistical provisions for personal loans) • Act on Bankruptcy and Remedy Proceedings strengthened creditor rights • Reduction of mandatory reserve requirements • Remaining vulnerabilities /challenges • Low average level of wealth • High unemployment • Inefficient public sector • Rapid increase in personal debt • Tough competitive environment has reduced margins

21. Diversified Foreign Ownership of Polish Banks Foreign banks control 67% of banking assets as of June 30, 2004 % of total banking sector assets by banks by country of origin

22. Turkish Banking Industry • Remaining vulnerabilities/challenges • Increase lending in a low inflation environment after years of easy profits from trading and investing in government bonds (in high inflation environment) • Privatization of large state banks will be difficult • Private sector banks weakened by recession of 2001-2002 • Increasing foreign competition

23. Kazakhstan Banking Industry Effective measures and policies • Relatively strong and independent regulator • Successive reformist central bankers • Group-level consolidated supervision enhances transparency • Mandatory reporting under IFRS • Enforceable creditor rights to collateral Remaining vulnerabilities/challenges • Fast credit growth undermines asset quality and capitalization • High single-party and sectoral concentrations • Weak transparency with respect to bank ownership • Risky expansion outside Kazakhstan • High proportion of international borrowing (rollover risk)

24. Ukrainian Banking Industry Effective measures and policies • New law on securing creditors' rights may improve the legal status of creditors • Deposit insurance provides limited coverage of deposits at private banks • The draft law on allowing foreign banks to open branches should promote competition Remaining vulnerabilities/challenges • Pervasive practice of intragroup lending • High single-party and sectoral concentrations • Obscure bank ownership • Weak/uncertain creditor's rights • Poor and often tardy disclosure of financial performance