1

Reform in the SEEEs: the role of the EU

Bank of Greece – University of Oxford (SEESOX) Conference,

Athens, 16 October 2009

Peter GrasmannEuropean Commission,

Directorate General for Economic and Financial Affairs*

* The views expressed in this presentation are exclusively those of the speaker and do not necessarily reflect those of the European Commission

2

Overview

1. Traditional EU support to the region

2. The crisis and EU-SEE relations

3. EU policy response to the crisis

4. Effects / outlook

5. Remaining agenda

6. Conclusion

3

1. Traditional EU support to the region

2. The crisis and EU-SEE relations

3. EU policy response to the crisis

4. Effects / outlook

5. Remaining agenda

6. Conclusion

4

The political geography:• Member

States• Candidate

countries (at different stages of accession negotiations)

• Potential candidate countries

5

The traditional modes of support delivery

1. “Pre-accession anchor”: incentive and guidance for economic and political stabilisation and reform. This becomes more powerful during accession negotiations.

2. Technical assistance and peer pressure

3. Financial support: Regional/structural funds, BOP assistance (MS)

Pre-accession instrument (IPA), macro-financial assistance (MFA) (CC+PCC)

4. Visa liberalisation

6

The Pre-accession instrument

Institution building

Cross-border coop.

potential candidate countries

Human resources

devel.

Regional develop-

ment.

Rural de- velopment

Cross-border coop.

Institution building

Croatia, the former Yugoslav Rep. of Macedonia

Pre-accession instriument (IPA) 2009- 2011, indicative planning - EUR million

Annually around EUR 240 million for HR+MK (candidate countries), and around EUR 500 million for potential candidate countries

7

Visa liberalisation

• 15 July 2009: European Commission proposes visa free travel for citizens of the former Yugoslav Rep. of Macedonia, Montenegro and Serbia to Schengen countries with new biometric passports. Proposal must be approved by the Council.

– The former Yugoslav Republic of Macedonia has met necessary conditions.

– Montenegro and Serbia: entry into force of visa waiver depends on fulfilment of all remaining conditions by the date of adoption of the proposal by the Council.

8

Visa liberalisation (II)

– Albania and Bosnia and Herzegovina: have not yet fulfilled all conditions (pending: fight against organised crime and corruption, weaknesses in the procedure for delivering passports and in border and migration management). If conditions are met, Commission might make a new proposal including these countries by mid-2010.

– Residents of Kosovo (UNSCR 1244/99) will not yet benefit from visa liberalisation as technical requirements not yet met.

9

Enlargement / accession

– Momentum of further enlargement has slowed after the end of 5th wave of enlargement

– Decline in popular support

– Issue is currently not high on the agenda of Member States

30

40

50

Oct04

Apr05

Oct05

Apr06

Oct06

Apr07

Oct07

Apr08

Oct08

Apr09

for against

Views of EU citizens on further enlargement

Surce: European Commission

10

Enlargement / accession negotiations

– Candidate country since 2004

– Negotiations started in 2005

– Some delay due to, now resolved, border dispute with Slovenia

– recently reacceleration: On 2 October, 6 further negotiation chapters were opened and 5 closed.

– Now 28 chapters are opened and 12 provisionally closed.

– Candidate country since 2005, but no start of accession negotiations

– Commission proposed on 14 October to start accession negotiations (to be approved by Council)

The former Yugoslav Republic of Macedonia

Croatia

11

1. Traditional EU support to the region

2. The crisis and EU-SEE relations3. EU policy response to the crisis

4. Effects / outlook

5. Remaining agenda

6. Conclusion

12

Sharp contraction in lending, in particular to enterprises …

-10

-5

0

5

10

15

20

2004 2005 2006 2007 2008 2009

annual rate of changemonthly rate of change, annualised

Euro area total MFI loans outstanding to non-financial corporations (sa and wda)

Soure: ECB, own calculations

%

-10

-5

0

5

10

15

20

2004 2005 2006 2007 2008 2009

annual rate of changemonthly rate of change, annualised

Euro area total MFI loans outstanding to private households (sa and wda)

Soure: ECB, own calculations

%

13

Effects on real economy – fast, massive

80

90

100

110

120

2004 2005 2006 2007 2008 2009

Total manufacturingIntermediate goodsCapital goodsConsumer goods

EU - Industrial production, s.a.2005=100

-20

-10

0

10

2004 2005 2006 2007 2008 2009

Exports Imports

Euro area - foreign trade with non euro area, change over last 3 months, s.a.percent

14

Trade spillover

-50

-25

0

25

3 07 6 07 9 07 12 07 3 08 6 08 9 08 12 08 3 09 6 09

BG RO

HR Total non-EU -50

-25

0

25

3 07 6 07 9 07 12 07 3 08 6 08 9 08 12 08 3 09 6 09

AL BH

MK RS

EU merchandise imports (EUR values), annual growth rates in %

15

Bank linkages

• Strong build up of foreign positions in South East Europe over the past 5 years

• Direct lending and commercial presence as vehicles of foreign banks’ market participation

-5

0

5

10

15

20

25

30

2004 2005 2006 2007 2008 2009

Bulgaria and Romania

Western Balkans

External positions of BIS reporting banks vis-à-vis the banking sector, net, % of GDP

Source: BIS, IMF, own calculations

16

Bank linkages (II)

• Main drivers: EU banks

• Only recently there has been a correction

-2000

-1000

0

1000

2000

2004 2005 2006 2007 2008 2009

All countriesEU*

External positions of banks (total) - exchange-rate adjusted changes

USD bn

Source: BIS - *BIS-reporting countries

17

SEE and the EU: the contribution of the crisis

– The financial and economic crisis has a severe and lasting effect on economic stabilisation in SEE and integration with the EU, unless the crisis is in the EU itself properly addressed.

– The crisis was accompanied by a massive slowdown in cross-border economic transactions and momentum for political integration

– Crisis resolution, if not done properly, can aggravate this development

18

1. Traditional EU support to the region

2. The crisis and EU-SEE relations

3. EU policy response to the crisis

4. Effects / outlook

5. Remaining agenda

6. Conclusion

19

o July 2009: €100 million budget support for Serbia (first time budget support via IPA)

Two tranches, each EUR 50 million, autumn 2009 and first half 2010

Conditions for payment: o IMF programme compliance o specific conditions

(short-term reform in public finance management, integration with the EU, implementation of laws on competition and state aid control)

IPA –crisis-related ad-hoc measures

20

o August 2009: € 39 million financial crisis response package for Bosnia and Herzegovina

Support of development of SMEs, investment in infrastructure transport, environment and energy; funding of Deposit Insurance Agency

These EU grants are part of overall Crisis Response Package for the WB that should total €150 million in EU grants and €600 million in IFI loans (i.e. EIB, EBRD, KfW)

IPA - crisis-related ad-hoc measures (II)

21

o The EU, in close co-operation with major IFIs, tried to secure a continued engagement of major European banks in the countries in the region.

o This initiative tried to address a possibly destabilising disorderly rush of foreign banks out of individual countries, in particular programme countries.

o For some (i.e. Hungary, Romania, (Latvia) Bosnia and Herzegovina, Serbia) formal discussions led last spring to informal (not legally binding) agreements

Banks to maintain their country exposure as compared to a certain, defined, reference date.

Maintaining orderly bank behaviour

22

o Problems Monitoring and enforcement Deleveraging made impossible? Knock on effects on other markets?

Regional approach?

Maintaining orderly bank behaviour (II)

23

Overriding priority: Stabilising the EU economy

1. Stabilisation of EU financial sector and economy has emerged as main priority, for the EU and the non-members in South East Europe

2. Main emphasis

Stabilisation and repair of the banking sector

Support to the economy: public spending and structural reform

24

EU public support to banks across MS

0

10

20

30

BE BG CZ DK DE EE EL ES FR IR IT CY LV LT LU HU MT NL AT PL PT RO SI SK FI SW UK

EU public interventions in the banking sector (total effective measures - % of GDP, as of end August 2009)

171

EU average

25

Stress testing of banks

• EU asked the Committee of European Bank Supervisors (CEBS) to coordinate an EU-wide test of the banking system’s resilience to shocks. – COM and ECB input for economic variables and

risk parameters – Test was applied by national supervisors on 22

major cross-border institutions with.• Purpose

– Information: consistent and comparable results – Confidence building: overcome negative effects

of different and often inaccurate estimates of likely bank exposures

• Results were delivered in September and are being assessed

26

Monetary support

Eurosystem's lending to MFI (EUR billion), Jan. 2007- Jun. 2009

0

10

20

30

40

50

Jan 07 Jul 07 Jan 08 Jul 08 Jan 09

GR ITLU PTSI SKFI AT

Eurosystem's lending to MFI (EUR billion), Jan. 2007- Jun. 2009

0

25

50

75

100

125

Jan 07 Jul 07 Jan 08 Jul 08 Jan 09

0

50

100

150

200

250

IEESNLDE (rhs)fr (rhs)

27

Exceptional financial assistance to Member States

• 3 Member States particularly hit by crisis (Hungary, Latvia, Romania)

• Very high external and public financing needs

• Hence, EU balance-of-payments support

• Burden sharing with other donors (esp. IMF)

• Economic policy conditionality and tranching

• Also increase of total amount for EU BoP assistance: EUR 12 billion EUR 25 billion EUR 50 billion

Hungary Latvia Romania

Total assistance 20 7.5 20

EU (Art. 119) 6.5 3.1 5

Instalment 1 2 1 1.5

Instalment 2 2 1.2

IMF 12.5 1.7 12.95

Instalment 1 4.9 0.6 5

Instalment 2 2.3

Other multilaterals 1 0.5 2

Bilaterals* 2.2

Balance-of-payments assistance to Member States (EUR billion)

* SE, DK, FI, CZ, PL, EE

28

Supporting the economy

• The implementation of the European Economic Recovery Programme is on track. – Projected cumulative 5 percentage points

of GDP of overall support to the EU economy in 2009 and 2010

– Stimulus measures are estimated by Commission services to contribute about ¾ of a percentage point to real GDP growth in 2009 and about ⅓ of a percentage point in 2010

29

The European Economic Recovery Programme (EERP)

• Adopted on (26 Nov 2008)

• Monetary and credit conditions with role for central banks, banks, EIB and EBRD

• Fiscal policy1. should be timely, temporary, targeted and co-ordinated

2. should mix revenue and expenditure instruments

3. should be conducted within the Stability and Growth Pact

4. should be accompanied by structural reforms that support demand and promote resilience

30

The EERP (II)

• Actions in the four priority areas of the Lisbon Strategy in order to adapt to long-term challenges and to raising potential growth

People 1. Launch a major European employment support initiative

2. Create demand for labour

Business 3. Enhance access to financing for business

4. Reduce administrative burdens and promote entrepreneurship

Infrastruc-ture and energy

5. Step up investments to modernise Europe's infrastructure

6. Improve energy efficiency in buildings

7. Promote the rapid take-up of "green products"

Research and Innovation

8. Increase investment in R&D, Innovation and Education

9. Develop clean technologies for cars and construction.

10. High-speed Internet for all

31

Roadmap for regulatory reform

EU roadmap for regulatory reform in response to the financial turmoil focuses of 4 key areas:

1. Transparency (adequacy of disclosure of banks' exposures relating to securitisation and Special Purpose Vehicles)

2. Valuation standards (valuation of illiquid assets and asset valuation standards used by non-bank investors)

3. Prudential framework, risk management and supervision

4. Market functioning (credit rating agencies, securitisation models, non-regulated debt markets and the mis-selling of mortgage credit)

32

Regulatory reform: in high gear

Proposals adopted, close to adoption, or in preparation on a wide range of issues

Capital requirements of banks

Defining Tier I and hybrid capital

Solvency requirements

Pay structures and transparency

Cross-border crisis management in banking

Hedge funds

OTC trading

Rating agencies

33

Regulatory reform: of particular interest for SEE

Some proposals might have a more direct and tangible impact on banking in SEE

•Capital requirements of banks: foreign currency mortgage lending

•Cross-border resolution of individual banking crises

34

European Systemic Risk Board

• Establishment of a new framework for macro-prudential supervision, a European Systemic Risk Board

• It will assess potential threats to financial stability and, where necessary, issue risk warnings and recommendations for action and monitor their implementation.

• to be composed of representatives of central banks, supervisors, Commission and EFC,

ECB General Council will elect the chair

35

European System of Financial Supervisors

• Establishment of European System of Financial Supervisors (three new European Supervisory Authorities for banking, insurance and securities markets)

• Objectives: – upgrading the quality and consistency

of national supervision, – strengthening oversight of cross-border

groups through the setting up of supervisory colleges

– establishing a European single rule book applicable to all financial institutions in the Single Market

36

European System of Financial Supervisors (II)

• Binding and proportionate decision-making powers – in respect of whether supervisors are

meeting their requirements under a single rule book and relevant EU law, and

– in case of disagreement between home and host state supervisors, including within colleges of supervisors.

• Supervisory powers as regards credit rating agencies

37

Defending a level playing field in EU banking

• Commission recognises that crisis justified the granting of aid on the basis of Art. 87(3)(b) EC.

• It set out a coherent framework for the provision of public guarantees, recapitalisation measures and impaired asset relief by MS.

• Main rationale: – ensure that rescue measures can pursue

objectives of financial stability and maintenance of credit flows,

– minimising distortions of public interventions between beneficiaries of aid in different MS, beneficiaries with different risk profiles and between beneficiaries and banks without aid

38

1. Traditional EU support to the region

2. The crisis and EU-SEE relations

3. EU policy response to the crisis

4. Effects / outlook5. Remaining agenda

6. Conclusion

39

Future of financial intermediation in Europe: market view

• Since March strong rebound of financials (+ ~40% total, + ~90% financials)

0

25

50

75

100

125

1987 1990 1993 1996 1999 2002 2005 2008

Total, 2005-07=100Financials, 2005-07=100Financials/total

Euro area DJ Euro STOXX - Price index

0

25

50

75

100

125

Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09

Total, 2005-07=100Financials, 2005-07=100Financials/total (%)

Euro area DJ Euro STOXX - Price index

0

25

50

75

100

125

1987 1990 1993 1996 1999 2002 2005 2008

Total, 2005-07=100Financials, 2005-07=100Financials/total

Euro area DJ Euro STOXX - Price index

40

Market correction went far

• This rebound seems ahead of actual business conditions for banking sector leading to quickly rising P/E ratios

0

10

20

30

2004 2005 2006 2007 2008 2009

0

1

2

3

P/E Ratio (lhs)Price to book value (rhs)

Euro area DJ Euro STOXX - Banks

41

… with wide dispersion

• But large and persisting differences among institutions (and countries)

0

20

40

60

80

100

0 20 40 60 80 100

Share prices of major European banks(average 2006-07=100)

February-March 2009

Se

pte

mb

er

20

09

42

Short-term recovery expected

• Short-term expectations: modest recovery in sight and largely discounted

• Rising demand for lending

-40

-20

0

20

40

2007 2008 2009

differencepast 3 monthsnext 3 months

ECFIN Business surveys - financial inter- mediation* (EU): evolution demand

*without insurance, pension funds

% balance

43

Demand for lending and the economy

• Similar factors are driving demand for lending to enterprises

ECB bank lending survey July 2009

-75

-50

-25

0

25

2004 2005 2006 2007 2008 2009

Fixed investmentMergers&acquistionsDebt restructuring

Enterprise loans (change over past 3 months, factors affecting demand, balance of replies)

44

Short-term recovery expected

• Confidence indicators back to levels of 1st stage of crisis (summer 2007 - autumn 2008)

-40

-20

0

20

40

2006 2007 2008 2009

EU euro area

ECFIN Business surveys - financial inter- mediation*: financial confidence indicator

*without insurance, pension funds

% balance

45

Economic outlook: Commission Spring forecast

• Slow recovery for the 2nd half of 2009 and for 2010

• Even in 2010 growth dynamics is expected to remain below pre-crisis levels

• EU will trail the US

• 2nd quarter was probably better than forecast (for euro area: forecast -0.7%, outturn -0.1%

• New forecasts on 19 September (interim) and in November (full-fledged)

46

Economic outlook: Commission Spring forecast (II)

-4

-2

0

2

2004 2005 2006 2007 2008 2009 2010

GDP (% over previous year)

2009/2010: ECFIN spring 2009 estimates and forecasts

annual figures

US

EU-27

-10

-5

0

5

2004 2005 2006 2007 2008 2009 2010

GDP (% over previous quarter, annual rates)

ECFIN spring 2009 forecasts as of 2nd qu. 2009 (US 3rd qu.)

quarterly figures EU-27

US

47

Economic outlook: Commission Spring forecast (III)

Demand components:• Mainly recovery of external trade and less

sharply falling investment• Government consumption with consistently

positive growth

48

Prospects: Commission Interim forecast September 2009

• In general confirmation of findings and forecasts of Spring forecast

• Some reassessment of individual Member States:

Germany and France stronger than foreseen in spring

• Spain, Italy, UK somewhat weaker

DG ECFIN Interim forecast 14 September 2009

Germany -3.5 0.3 0.7 0.1 -5.1 -5.4

Spain -1.6 -1.1 -0.4 -0.2 -3.7 -3.2

France -1.3 0.3 0.4 0.3 -2.1 -3.0

Italy -2.7 -0.5 0.2 0.1 -5.0 -4.4

Netherlands -2.7 -0.9 -0.4 0 -4.5 -3.5

Euro area -2.5 -0.1 0.2 0.1 -4.0 -4.0

Poland 0.3 0.5 0.1 0 1.0 -1.4

United Kingdom -2.4 -0.7 0.2 0.5 -4.3 -3.8

EU27 -2.4 -0.2 0.2 0.1 -4.0 -4.0

2009 (%, q-o-q)May 2009

forecast

Quarterly figures: working-day and seasonally adjusted, annual figures: unadjusted

Annual GDP

2009 (%, y-o-y)

Q1 Q2 Q3 Q4

Quarterly GDP

49

Economic outlook – medium term

• Crisis might have a more long-lasting effect on potential growth in the EU

• Due to

– changes in financial intermediation

– Depletion of fixed assets and low investment

50

1. Traditional EU support to the region

2. The crisis and EU-SEE relations

3. EU policy response to the crisis

4. Effects / outlook

5. Remaining agenda6. Conclusion

51

Home-host countries

•Home-host country cooperation for banking supervision and banking crisis management

52

Cross-border banking and the size of banks

• Size of large banks has further increased in Europe

• These are prominently represented in cross-border activities/ representation in emerging economies

• Discussion about size of systemic banks might have a back lash

90

100

110

120

130

140

2006 2007 2008

0.55

0.7

0.85

1

1.15

1.3top 15no 16-100ratio (rhs)

European banks, volume of assets 2006=100

53

Fiscal rebalancing

• Automatic stabilisers and discretionary spending let government deficits globally surge

25

30

35

40

45

50

2004 2005 2006 2007 2008 2009 2010

Euro area expenditureEuro area revenueUK expenditureUK revenue

General government budget (% of GDP)

2009/2010: ECFIN spring 2009 estimates and forecasts

25

30

35

40

45

50

2004 2005 2006 2007 2008 2009 2010

US expenditureUS revenueJapan expenditureJapan revenue

General government budget (% of GDP)

2009/2010: ECFIN spring 2009 estimates and forecasts

• Without massive policy change, debt levels will rise dramatically

54

Exit from bank bailout

2. Bank and capital holders should contribute to restructuring costs as much as possible, to address moral hazard and to create appropriate incentives for future behaviour.

This is achieved by appropriate prices for state support, to avoid that aid is used to finance market-distorting activities not linked to the restructuring process.

3. National interventions and differences between MS’ resources can harm the internal market.

Temporary restrictions on acquisitions by beneficiaries or other behavioural safeguards will tackle competition distortions between banks with and without public support and banks in different MS.

1. Beneficiary banks must restore long-term viability without state support.

A thorough restructuring plan must be based on stress testing and full disclosure of impaired assets.

Principles Commission Communication of 22 July:

55

Exit from bank bailout (II)

• Applying these principles, exit from public support to the banking sector is a complex co-ordination challenge for the EU

• Specifics are currently under discussion

• Proper handling is also crucial for the banking relations between the EU and the SEE region

56

Exit from extraordinary monetary easing

• Readjustment of global liquidity

• Reducing balance sheets of central banks

• A start is made, it will be partly “automatic”, but it will take much longer 0

500

1000

1500

2004 2005 2006 2007 2008 2009

0

200

400

600

Euro area (lhs) US (rhs)

Central banks' claims on banks (USD billion)

Source: IMF

57

1. Traditional EU support to the region

2. The crisis and EU-SEE relations

3. EU policy response to the crisis

4. Effects / outlook

5. Remaining agenda

6. Conclusion

58

Conclusion

1. Traditional means of EU support to the region are intact.

2. Crisis had serious affected the economic relations between SEE and the EU.

3. EU repair of its financial system and support to its economy are underway. Some first signs of success are traceable.

4. Many issues remain to make Europe more shock proof and ready to engage in a next step of integration with SEE

59

Thank you very much for your attention