European Central Bank says E.Europe bank-asset risks remain

December 18, 2009

By Boris Groendahl

VIENNA, Dec 18 (Reuters) – Western European banks could still be hit by a further rise in bad debt in emerging Europe if the economic downturn is worse than expected or if currencies decline, the European Central Bank (ECB) warned on Friday.

The ECB said in its half-yearly financial stability report that vulnerabilities eased in the region, which includes the new EU member states as well as Ukraine and others in the former Soviet Union and Croatia or Serbia the former Yugoslavia.

The region suffered a sudden reversal of fortunes this year when a boom driven by western bank loans, exports, investment, and consumer spending slammed to a halt and caused steep contractions in almost every country.

It has been pulled back from the brink by global policymakers’ success in beating back the worst of the financial crisis and restoring liquidity to markets, but the ECB said the situation remained “fragile”.

A general economic deterioration could let the expansion of bad debt pick up again and could unveil some banks’ overexposure to certain countries or sectors, the ECB said.

“In the wake of the weakening of economic activity in the CEE region, the deteriorating quality of bank assets is likely to become an important vulnerability, particularly in economies affected by large contractions in output,” it said.

“Rising unemployment, lower incomes and corporate defaults are likely to lead to a further increase in loan delinquencies and a further deterioration of bank loan portfolios,” it said.

The region’s habit of lending in foreign currencies such as the euro, the Swiss Franc and the U.S. dollar keeps alive the risk that borrowers default if local currencies decline.

“In countries with a large stock of outstanding foreign currency credit, a renewed weakening of these currencies could trigger a significant further deterioration in banks’ asset quality,” the ECB said in the report.

Above all, if markets returned to the risk aversion seen earlier this year, this would aggravate the pressure on banks.

“Potential capital outflows triggered by, for example, a possible renewed increase in risk aversion towards the region could result in severe loan losses, eroding the capital and asset quality of parent banks and their subsidiaries,” it said.

 

EURO ZONE BANKS DOMINATE

After a buying spree in the past 15 years, euro zone banks own most of the banking sector in eastern Europe, with UniCredit, Raiffeisen International, Erste Group Bank, Societe Generale and KBC being the biggest players by assets.

Their exposures vary widely however, both in terms regional presence and the sectors they are exposed to, and in terms of the eastern European share of their total assets.

The ECB warned, without identifying the banks it was alluding to, that some of them may be prone to cluster risks which could emerge if bad debt was to rise again.

It said that risks included the “possible unearthing of portfolio concentration risks and insufficient differentiation across sectors, currencies and geographical entities.”

Those factors all played a role in the bailout of Austrian bank Hypo Group Alpe Adria, which was nationalised on Monday after German owner BayernLB walked away.

Hypo is very exposed to the real estate and leasing business in Croatia and other former Yugoslav countries and is one of the major banks there. ECB President Jean-Claude Trichet personally intervened in the process and pushed for a bailout deal.

(Reporting by Boris Groendahl; Editing by Toby Chopra) ((boris.groendahl@reuters.com; +43 1 53112-258; Reuters Messaging: boris.groendahl.reuters.com@reuters.net))

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