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Eastern Europe, Russia and Central Asia. World Bank Conference The 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.
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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
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?
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
Global Ranking of Emerging Market Banking Systems by Industry and Economic Risk * For comparison purposes; Standard & Poor’s classifies these countries as mature markets
Over Past Five Years, Russian Bank CreditworthinessLagsSovereign
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
Russian Bank FailuresMay – August 2004 * Operations suspended in July 2004, but license not withdrawn
Russian Retail Deposit Growth in 2004 Retail deposits approximately $70 billion at year-end 2004 Source: Central Bank of Russia
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
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
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?
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
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
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
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
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
Banking Sector Undevelopped in EEMEADomestic Credit to Private Sector to GDP Source: Standard & Poor’s Data as of year-end 2003
Domestic Credit to Private Sector to GDPPotential for Growth in EEMEA and LA
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
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
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
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)
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