The challenge of building The challenge of building financial sectors ahead of the financial sectors ahead of the
euroeuro
Piroska M. NagyPiroska M. NagyEBRDEBRD
July 11, 2006July 11, 2006
Main messages Main messages
• There is no convergence – “Maastricht” - criterion for financial sectors
• Despite - or because of ? - this, the EU-8’s financial sector has converged to that of the euro zone probably more than any other sector or policy area This has been the combined result of “top-down”legal/regulatory Europeanization and “bottom-up”Europe-affinity via privatization to EU-15 foreigners Structures and regulatory frameworks have converged rapidly but systemic risks in EU15 and EU-8 are different a main issue for euro membership
TodayPrivatisation mostly completeFewer banks but still too manyMany banks owned by foreign strategic investorsMaturities extended
1989State ownership
Too many banks initially
Many banks owned as domestic ‘pocket banks’
Very limited medium and long term lending
Reform progress in the financial sector Reform progress in the financial sector of the EUof the EU--88
Reform progress in the financial sector Reform progress in the financial sector of the EUof the EU--88
TodayHigher level of deposits
Legal reform has taken place
EU convergence –Basel II/CRDStock markets set up and capital market products gradually introduced
1989Lack of confidence and hence banking sector depositsLegal uncertainty and law not market-orientatedLow regulatory standardsNo capital markets
A very bumpy processA very bumpy process
Starting point: absolute state interventionEarly period: chaotic, with mixed state ownership and private banks with insider interest and still no proper regulatory frameworkSeries of bank crises resulting from past liabilities as much as poor financial market governance (bank corporate governance & regulatory framework). Costs up to 20% of GDP
Source: P. M. Nagy in Enlarging the Euro Area, edited by K. Dyson, Oxford University Press, November 2006
A very bumpy processA very bumpy process
“Bottom up” European affinity. Privatization primarily to EU-based foreigners. Major improvements in corporate governance“Top down” Europeanization. Regulatory framework convergence as precondition for EU accessionSo how ready are financial sectors for the euro?
Low level of bank intermediation -credit
Domestic credit to GDP
Slovenia
Austria
Germany
Italy
US
SEE average
SEE candidates average
Czech Rebublic
EstoniaLatvia
Lithuania
Hungary
Poland
SlovakiaCEB average
EU-15 average
0%
20%
40%
60%
80%
100%
120%
140%
160%
180%
200%
- 5,000 10,000 15,000 20,000 25,000 30,000 35,000
GDP per capita (2004)
Dom
estic
cre
dit t
o G
DP
(200
4)
0102030405060708090
Albania BiHBulgari
aCroatia
Czech Republic
Estonia
HungaryLatv
iaLithuania
Poland
RomaniaRussi
aSerb
iaSlovakiaSlovenia
Ukraine
Non-government credit/GDP in %, 2004
Source: EBRD, updating and extending the model by Cottarelli et al (IMF)
PredictedActual
Private sector credit in the region is lower Private sector credit in the region is lower than predicted by economic modelsthan predicted by economic models
Where bank loans go? Where bank loans go? To householdsTo households
Share of loans in total loans (%)
0%
10%
20%
30%
40%
50%
60%
CEE EU15
Corporate loans/totalloansHousehold loans/totalloansMortgage loans/totalloans
Stock market capitalization in % of GDP 2004
0%
20%
40%
60%
80%
100%
120%
140%
Slovakia
Romania
Czech R
ebublic
Hungary
Lithuan
iaPolan
dAustr
iaCro
atiaGerm
any
Italy
Estonia
France
United K
ingdom CEB SEE
EU-15
Stock market capitalization has reached that Stock market capitalization has reached that of Austriaof Austria’’s and approaching that of s and approaching that of GermanyGermany
0%
20%
40%
60%
80%
100%
CEE average EU15 average
Structure of Corporate Financing
Financing of corporates is indeed Financing of corporates is indeed changing rapidlychanging rapidly
Source: EBRD
0%
50%
100%
150%
CEE average EU15 average
Corporate financing as % of GDP
Stock market
Debt issue
Loans
Deposit to GDP
Slovenia
Austria
Germany
Italy
US
SEE average
SEE candidates average
Czech Rebublic
Estonia
Latvia
Lithuania
HungaryPoland
SlovakiaCEB average
EU-15 average
0%
20%
40%
60%
80%
100%
120%
- 5,000 10,000 15,000 20,000 25,000 30,000 35,000
GDP per capita (2004)
Dep
osit
to G
DP
(200
4)
Low level of bank intermediation -deposits
Savings allocation (% of GDP)Savings allocation (% of GDP)
0%
50%
100%
150%
200%
CEE average EU15 average
Savings Allocation % of GDP
0%
20%
40%
60%
80%
100%
CEE average EU15 average
Structure of Savings
Deposit
Pension funds
Life insurance
Growth ratios of different saving pools in Hungary 2003-2006
0%
20%
40%
60%
80%
100%
120%
140%
160%
180%
UCITS Life insurancereserves
assets managed bypension funds
households deposit
Lowest growth
Corporate governance in the regionCorporate governance in the region
4426144Total
830Caucasus and Central Asia4130Russia
21984SEE and CIS-Europe 38800
EU-8 plus Croatia
Number of
banks2 tier
separation2 tiermixedUnitary Region
* 2004
Survey on board structures in EBRD's investee banks by region *Survey on board structures in EBRD's investee banks by region *
While in the EU15 While in the EU15 ……
The dominant structure is still the unitary board (E-8 has ‘leap-frogged?’)Regulations focus on ensuring truly independent board members and disclosure requirements (often mandatory for listed banks)
Foreign ownership is much higher in EUForeign ownership is much higher in EU--8 8 with a few banks dominating the marketswith a few banks dominating the markets
0%10%20%30%40%50%60%70%80%90%
100%
German
yIta
lyFra
nce
United K
ingdom
Austria
Romania
Hungary
Poland
Czech R
ebublic
Lithuan
iaCro
atiaSlova
kiaEsto
niaCEB SEE
EU-15
Share of foreign banks in total bank assets (%)
And the EUAnd the EU--88’’s regulatory framework s regulatory framework is EU compliantis EU compliant
Basel II CRDDeposit insuranceSolvency II
… you name it
Rapid credit growth reduces capital Rapid credit growth reduces capital adequacyadequacy
05
10152025303540
2000 2001 2002 2003 2004 2005
BulgariaCroatiaCzech REstoniaHungaryLatviaLithuaniaPolandRomaniaSlovak RRussia
Basel
CEE capital adequacy and portfolio CEE capital adequacy and portfolio quality (%)quality (%)
While capital ratios have reduced to below EU15 average in the EU8
… asset quality (e.g., NPLs) is still weaker in the EU8
0
5
10
15
2005
Basel
0
1
2
3
4
5
2005
EU15EU8 EU8
EU15
Different types of systemic risks Different types of systemic risks
Systemic risks of the financial sector can be markedly different:– Foreign ownership and Basel II/CRD: (i)
asymmetric shock transmission; (ii) CRD home-host issue; (iii) ownership concentration
– High banking sector concentration top 5 banks own almost 70% of assets on average
– High risk concentration: large exposure, forex without hedging
– Yet lack of risk mitigation/transfer– Risks inherent in any very rapid credit expansion
Systemic risk matrix for the EBRD Systemic risk matrix for the EBRD countriescountries
BSIE BEL KYR
AZR RUS SER MOL UKRUZB TKM ARM GEO TAJ
BiH KAZD ALB
POL MAC BUL ROM LATCRO SLK SLV LIT HUN
C
CZEB
ESTA
1 2 3 4
Macroprudential indicator
UK
Belgium, Switzerland
Austria, Germany
South Africa
Italy, Portugal, Spain
China, Argentina, Egypt
ConclusionsConclusions
In terms of levels, financial sectors are rapidly catching upIn terms of structures, catch-up is almost completeIn terms of financial market governance, convergence is almost completeHowever, systemic risks of the financial sector can be markedly different, which can become a problem when joining the euro.