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Corporate Governance
of Banks in Eurasia
Dr Sibel Beadle,Principal Banker, EBRD
Role of Company Secretary in Bank
Governance
London, United Kingdom
30 April 2008The views expressed in this paper are those of the author and do not necessarily represent the opinions of the OECD
or its Member countries or the European Bank for Reconstruction and Development
Impact on EBRD Countries of
Operation
Sub prime Exposure
– What Happened?
– Exposure of Financial Sector in EBRD Countries of Operation
Liquidity Squeeze
– Vulnerability – Credit growth and Dependence on External Funding in EBRD Countries of Operation
– Alternative Funding Sources?
How did the sub prime crisis start?
Initially – US housing prices, started to fall
and sub prime mortgage borrowers started to
default
First half of 2007 – Acknowledgement from
the FED that the broad based defaults could
lead to $50 Billion of write downs
August 2007 – Crisis became visible when
ECB had to inject the first Euro 95 Billion into
money markets
Current Level of Write Downs
SocGen $4bn
UniCredit $0.8bn
RZB $0.04bn
Citi
Merrill
UBS
Morgan Stanley
$0
$5,000
$10,000
$15,000
$20,000
$25,000
$30,000
$35,000
$40,000
Mortgage Related Write-Downs
(91 financial companies, 177bn)
Source: Moody's and BBC
How large are the losses?
Still uncertain
First week of February – Tokyo meeting –
German Finance Minister revealed that the
G7 thought losses could reach $400 bn
New write-downs since February
How could this happen?
October 2007 Fitch announces
– 26% of downgrades from all rated 2006 sub prime RMBS
– Many from investment grade to speculative grade
January 2008 Moody’s announces
– Downgrades on 53.3% of the 2006 vintage tranches (representing 93.4% of the deals backed by first- and second-lien sub prime mortgages)
– Downgrades on 38.2% of rated tranches of the 2007 vintage
February 2008 S&P announces
– Downgraded $183 billion out of $3.24 trillion in original issuances (an additional $588.31bn put on credit watch
– Securities that S&P downgraded from investment grade to speculative-grade did account for about 63% of the downgrades by original issuance volume
Downgrades are still continuing…
What does this mean concretely—
Structured Finance Rating changes S&P
AAA AA+ AA AA- A+ A A-
BBB
+ BBB BBB- BB+ BB BB- B+ B B-
CCC
+ CCC CCC- CC D
AAA 83.6 0.7 1.3 0.4 0.7 0.6 0.6 0.5 1.0 0.9 0.5 1.5 0.3 0.25 1.08 0.47 0.96 1.1 1.86 1.3 0.39
AA+ 84.6 2.1 0.7 0.9 1.5 0.3 0.4 1.9 0.1 0.4 2.5 0.04 2.63 0.09 0.09 1.23 0.04 0.18 0.04
AA 0.1 0.2 74.3 1.4 1.1 2.0 1.0 0.7 2.0 0.6 0.7 2.9 0.2 0.28 2.81 0.35 0.64 4.56 1.23 2.55 0.4
AA- 0.1 0.5 62.4 1.8 1.7 0.9 1.0 2.0 0.8 0.5 3.0 0.3 0.22 7.55 0.22 0.34 13.32 0.84 1.9 0.62
A+ 56.8 1.4 1.5 1.6 2.3 0.9 0.9 3.4 0.4 0.33 3.32 0.44 0.16 23.58 0.65 1.69 0.54
A 0.1 0.0 0.1 61.3 1.7 1.4 2.6 1.1 1.1 3.4 0.5 0.84 2.25 0.49 0.35 14.01 1.44 6.07 1.13
A- 0.1 47.9 2.9 3.3 1.3 0.7 4.0 1.1 0.6 3.79 1.02 0.23 23.14 0.88 7.45 1.67
BBB+ 43.2 2.4 2.3 1.8 4.9 1.2 0.97 4.56 0.92 0.15 25.72 0.36 8.66 2.87
BBB 0.0 0.1 0.0 52.8 2.4 2.6 4.4 0.8 0.97 4.63 0.73 0.32 14.46 1.67 11.71 2.37
BBB- 0.1 0.0 38.4 2.3 4.8 1.4 0.85 6.26 1.38 0.08 23.54 0.28 16.3 4.27
BB+ 24.9 2.5 1.4 1.06 5.42 1.36 23.91 0.48 26.52 12.49
BB 0.1 0.1 56.2 2.2 0.82 12.73 0.92 0.05 12.84 0.27 9.09 4.79
BB- 64.4 4.7 9.4 2.01 10.07 4.03 5.37
B+ 1.8 85.45 9.09 3.64
B 0.09 69.84 5.29 23.1 0.09 0.88 0.71
B- 83.3 2.08 12.5 2.08
Downgrades
Impact on EBRD Countries of
Operation
Sub prime Exposure
– What Happened?
– Exposure of Financial Sector in EBRD Countries of Operation
Liquidity Squeeze
– Vulnerability – Credit growth and Dependence on External Funding in EBRD Countries of Operation
– Alternative Funding Sources?
How is the liquidity squeeze
connected to the sub prime
High uncertainty in financial markets
– Increased risk aversion
– Initial uncertainty on exposure caused spill over to all
markets
– Spreads widened, funding has become expensive and
sometimes was not available any loner
Funding problems in EBRD countries where rapid
credit growth was heavily reliant on external funding
Differences of Western World vs.
EBRD Countries of Operation
Western Markets:
Asset Problems
Rest of the World:
Liquidity ProblemsWorldwide incl. EBRD countries
- Could lead to asset problems
over time
- Uncertainty in markets led to
difficulty in raising external funds
Risk Categories among EBRD
Countries of Operation
High risk factors:
– High credit growth mainly driven by wholesale funding—For example, banks in Kazakhstan (the worst hit country by the liquidity problem) and the banking system in the Baltic Countries
– Banking systems that do not have a sufficiently diversified funding base; in particular, those with a weak deposit base
– Countries that face other macro economic or financial problems (high deficits, large external imbalances, pressure on currency, housing bubble) are likely to be worse affected by the credit squeeze
Risk mitigating factors:
– Strong foreign exchange reserves—determined intervention by a central bank backed by strong foreign exchange reserves
– Strong presence of foreign banks—particularly, if the parent is willing and able to provide liquidity support
– Strong deposit base of the banking system
However, even in banking systems with high deposit levels deposits can move to large systemic banks or state banks—flight to quality/government guarantee
Or in countries with low level of deposits individual banks can have a strong customer base
Financial Intermediation and Credit
GrowthFinancial Intermediation – Bank Credit to Private Sector/GDP)
(2004 vs 2007)
2004
2004
2004
2004
2004 2
004
2004 2
004
20
04
2004
2004
2004 2
004
2004
2004
2004
2004
2004
2004
2004
2004
2004
2007
2007
2007
2007
2007
2007 2007
2007
2007
2007
2007
2007
2007
2007
20072007
2007
2007
2007
2007
2007
2007
0
20
40
60
80
100
120
140
160
180
200
Cre
dit
/GD
P (
in P
erc
en
t)
EU
CIS
Baltics
SEE
ETC
2004
By Region
Change in Bank Credit to Private Sector/GDP
(2004 - 2007)
0
10
20
30
40
50
60
Esto
nia
Latv
iaLi
thu
ania
Kaz
akh
stan
Ukr
ain
eSl
ove
nia
Bu
lgar
ia
Cro
atia
Ge
org
iaH
un
gary
Ru
ssia
Ro
man
ia
Cze
chM
old
ova
Mac
edo
nia
Po
lan
dSl
ova
kia
Aze
rbai
jan
Serb
iaA
rme
nia UK
Fran
ce US
BPS
CE
CIS
Baltics
SEE
ETC
Deposit Base by Region
Source: CEE Banking Sector Report; EBRD; Fitch Ratings. * or latest available
Baltics
CIS
CEE
SEE
ETC
Figure 2: Customer Deposits/Total Bank Assets (2007*)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
Alb
ania
Slo
ven
ia
Bu
lgar
ia
Mo
ldo
va
Mo
nte
ne
gro
Bo
snia
Mac
ed
on
ia
Cze
ch
Slo
vaki
a
Arm
en
ia
Cro
atia
Aze
rbai
jan
Taji
kist
an
Ukr
ain
e
Ge
org
ia
Ro
man
ia
Po
lan
d
Kyr
gyz
Lith
uan
ia
Esto
nia
Be
laru
s
Latv
ia
Hu
nga
ry
Serb
ia
Kaz
akh
stan
Ru
ssia
Foreign Ownership
Source: CEE Banking Sector Report; EBRD; Fitch Ratings
ETC
SEE
CEE
CIS
Baltics
Figure 3: Foreign Ownership (% of total assets)
0
20
40
60
80
100
Es
ton
ia
Czec
h
Slo
va
kia
Bo
sn
ia
Cro
ati
a
Ro
man
ia
Lit
hu
an
ia
Hu
ng
ary
Se
rbia
Bu
lgari
a
Ge
org
ia
Po
lan
d
Latv
ia
Arm
en
ia
Slo
ve
nia
Ukra
ine
Aze
rba
ija
n
Ru
ss
ia
Ka
za
kh
sta
n
Bela
rus
%
Increase in the Cost of Risk at the
Country Level
CDS, 5 Year Default, Foreign Currency Bps
0
50
100
150
200
250
300
350
Kazakhstan Ukraine Russia Poland Hungary Estonia
31 December 2006 31 December 2007 Peak Now, 29. April 08
x5.6
x4.5
x2.1
x1.7
x3.6
x2.2 x7.7
x2.9
x9.6
x5.3
x28.4
x17.0
Liquidity and Funding By Region --
Baltics
The largest vulnerability of the Baltics region is stemming from extraordinarily rapid credit growth prior to the credit squeeze
Depositor base of the Baltic countries is not as strong as in some other regions; only 50% of funding is provided by customer deposits.
Foreign ownership – high, but strategics have higher funding costs
Liquidity and Funding By Region -
Baltics The largest vulnerability of the Baltics region is stemming from extraordinarily
rapid credit growth prior to the credit squeeze
Depositor base of the Baltic countries is not as strong as in some other regions; only 50% of funding is provided by customer deposits.
Foreign ownership – high, but strategics also have higher funding costs
Overall, the majority of banks in the Baltics are controlled by Scandinavian banks—slow down in the Baltics would impact profitability of Scandinavian banks and increase of funding costs of the parent would influence profitability and growth of banking in the Baltics
– For example, currently 15 % of Swedbank’s total lending and more than 30% of its operating profit is stemming from Swedbank’s Baltic banking operations
– Swedbank’s wholly owned subsidiary Hansabank is the market leader in Estonia, Latvia and a major player in Lithuania.
– S&P to revise the outlook of Swedbank to negative from stable on December 18, 2007.
Fitch ratings changed the outlook for Latvia and Estonia to negative on January 31, 2008; prior to that Fitch had downgraded Latvia to BBB+ on August 17, 2007)
Liquidity and Funding By Region –
CEE/SEE Credit growth in EBRD countries that are a part of the EU have been moderate compared to
other regions—The high growth countries among the EU countries were Bulgaria and Slovenia.
Bulgaria as well as Slovenia has a very strong customer deposit base and customer deposits make up about 80 percent of total assets of the banking sector--except for Hungary for all countries in this group more than 50 % of funding comes via customer deposits
Foreign ownership is very high, often above 80
However, large variations in concentration of ownership. In some of the countries the presence of foreign banks is concentrated among a few large strategics. For example:
– Czech Republic, the three largest banks CS (Erste), CSOB (KBC), KB (Soc Gen), make up more than 50 percent of the banking sector assets
– Poland, other than UniCredit which owns Bank Pekao and Bank BPH (2nd and 3rd largest banks in the country), none of the foreign strategics have a larger than 7 percent market share
Therefore, the impact of the liquidity crisis in this region is rather complex and can often be influenced by:
– changes in the funding conditions of a few strategics
– or can be largely biased by strategic decisions—For example, in some of these countries, due to the competition among large international banks to retain or increase market share the increased funding costs have not been fully passed through to the end consumer, yet.
CEE/SEE
Source: EBRD, Monitoring Reports, Raiffeisen, CEE Banking Sector Report
Figure 5: Foreign Ownership--Parent Bank
(Percent of Total Banking Sector Assets)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100% Other Foreign
Bayern LB
Intesa
KBC
SocGen
RZB
UniCredit
Erste
Wholesale funding of the Strategics
Selected European Banks: Dependence on
wholesale financing as of March 2008
Rati
o o
f o
uts
tan
din
g d
eb
t secu
riti
es t
o t
ota
l
loan
s (
%)
Source: GFSR, April 2008, IMF, page 26
Original Sources: Bloomberg L.P.;Thomson Worldscope;and IMF
0
10
20
30
40
50
60
70
0 5 10 15
Average debt maturity in years
Swedbank
DnB
SEB
Handel
Dexia
Nati
Unic
Sanp
Raiff Dansk
Norde
BBV
Sant
Rabo
Erst
Liquidity and Funding - Kazakhstan
Kazakhstan has experienced one of the most exuberant credit growths prior to the liquidity squeeze—The sudden drying up of world wide credit in August led to a large disruption in the banking sector.
– Rapid growth in private credit was mainly funded by external credit.
– Further, the deposit base of banks was one of the weakest among the countries of operation
– Relative limited foreign ownership at the time, banks also had little alternative funding source
Nonetheless, the relatively strong FX reserves and the ability and willingness of the Kazakh authorities to intervene were very important in fending off the immediate distress situation that was created in August and September 2007.
Even in the case of Kazakhstan, which was the most affected country in the region, the rating for the country itself and for individual banks did not change materially, reflecting the very strong fundamentals the region has compared to historic episodes of financial turmoil
Liquidity and Funding - Russia
Among the CIS countries, Russia—while not immune—compared to other CIS less vulnerable to the liquidity squeeze (moderate to high credit growth)
Extraordinary FX reserves
– key role in providing great credibility to the Russian central bank during the height of problems
– was also recently acknowledged by S&P and led to a change in the outlook for the Russian sovereign to positive from neutral on March 11 2008
However, weaknesses in the funding base of banks exist
– Funding to small and medium sized banks is severely restrained
– Lowest ratio of customer deposits to total banking sector assets (among EBRD countries)
– Low foreign ownership of banks
– Government support for the smaller banks’ is likely to be less than the large players in the market.
Liquidity squeeze may accelerate consolidation in the banking sector, including potentially greater concentration towards the state sector
One distinct difference in Russia, compared to many other EBRD countries of operation, is that driven mainly by the strong oil prices and the solid economic growth, the corporate sector is still strong
– corporate as well as retail customers continue to ask for loans
– Banks (unlike in some other markets) can pass on the additional cost of funding to the customer, since the end customer is able as well as willing to pay for the higher cost.
FX Reserves of Russia
Foreign Exchange Reserve of Russia are Exceptionally
Strong driven by High Oil Prices
0.00E+00
5.00E+10
1.00E+11
1.50E+11
2.00E+11
2.50E+11
3.00E+11
3.50E+11
4.00E+11
4.50E+11
5.00E+11
RUSSIA
Liquidity and Funding By Region --
ETC
High credit growth but driven by low base
Resilience compared to historic experience
Going forward:
– Liquidity squeeze is likely to slowdown growth in
banking sector
– Slowdown in world GDP growth likely to impact
region
Thank you!