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After financing the upswing of the CEE countries, Austrian banks in particular are now seen as candidates for bankruptcy on the international financial markets – and probably unfairly so

The central and southeastern European "reform states" that were formerly part of the Soviet Union have been at the center of the global financial crisis in recent weeks: the drastic decline in industrial production and the simultaneous collapse of their respective economies have caused the previously successful growth model of these countries, which was based on foreign loans, to fail, according to the analysis departments of banks that are not heavily involved in these regions. Corresponding warnings were also issued by the rating agencies, of which Moody’s issued one on 17 December. February issued a serious warning regarding the lending banks.

According to the Bank for International Settlements (BIS), the involvement of Austrian financial institutions in this region is particularly dangerous. Euros in outstanding loans in this region. This is more than 80 percent of Austria’s annual economic output, and on the credit markets it is apparently a given that this potential threat far exceeds the possibilities of the Austrian government. In the event of a crisis, Austria would be threatened with national bankruptcy, which is reflected in the recent massive increase in risk premiums for Austrian government debt. So hat sich der Risikoaufschlag gegenuber deutschen Bundesanleihen innerhalb nur einer Woche auf 133 Basispunkte (1 BP = 0,01 Prozentpunkt) verdoppelt und liegt nun hoher als jener Spaniens, so dass im Euroraum derzeit nur noch Griechenland und Irland hohere Aufschlage zahlen mussen.

At first glance, the situation does indeed seem highly threatening, but the current hysteria, which formally broke the stock exchange prices of Austrian banks last week, seems only partially justified on closer inspection.

In fact, in the last 20 years Viennese banks have resumed their traditional role as financiers of the countries of the former Danube monarchy with quite a lot of zeal. Now the crisis revives the memory of 1931. At that time, only the collapse of the Vienna Creditanstalt, which had overdrawn itself with loans in the now again threatened regions, had triggered the global "Great Depression". The collapse of the largest bank in the region at the time forced a number of European banks into bankruptcy, and the global economic crisis, which had previously been concentrated in the USA, finally spread to Europe. In addition, there was a wave of bank failures in the U.S., which ruined more than half of the U.S. Banks. At that time, too, the interbank credit market was completely frozen for weeks, something that was never allowed to happen again on this scale until October 2009.

Today, Bank Austria, a direct successor to Creditanstalt, is at the center of the storm. The bank, which was taken over by the Bavarian HVB in 2000, had once again become the most important lender in the region within two decades. For its part, when HVB was taken over by the Italian Uncredit Group in 2005, Bank Austria was by far the most valuable "asset" the otherwise seriously ailing Munich-based bank had to offer.

Statistically, however, Bank Austria’s CEE credit exposure is now attributed to either Germany or Italy, so that the actual exposure of Austrian credit institutions may still be about one third higher than indicated by the BIS statistics – especially since Karnten-based Hypo-Alpe Adria, which is mainly active in the Balkans, has been part of Bayern LB since 2007.

However, two Viennese financial institutions, Raiffeisen International and Erste Bank, still rank second and third among the region’s biggest lenders. The Belgian major bank KBC also has a strong presence in the region, while Greek banks are very active in the Balkans and the Baltic banks are firmly in the hands of Scandinavian banking groups. It is striking that the globally active British and U.S. Banks are practically not active in the region. But they obviously preferred to invest their capital in subprime structures.

Catching up the transition countries with loans

Despite the huge CEE exposure of the Viennese institutions, however, a look at the facts should help to calm things down a bit. After all, when the successful catching-up of the European "transition countries" was analyzed before the outbreak of the financial crisis, the role of the Western European banks was seldom given any credit. These had, starting from today’s EU countries Poland, the Czech Republic and Hungary, then further and further east and in the Balkans, almost immediately after the collapse of the Soviet Union, started to take over and modernize the banking systems there. Although simpler products were offered than in the mother countries, the banks basically offered services on a Western level from the very beginning. While the lack of trade and investment financing and payment transactions were real bottlenecks in many Asian developing countries whose financial systems had not migrated to foreign hands, functioning systems were established in the ex-Comecon countries from the early 1990s onward, which probably made the rapid catch-up process possible in the first place.

At the beginning of this development, banks concentrated on financing the corporate sector and – even more strongly – the public sector. It was not until the late 1990s that banks expanded their offerings and turned their attention to private households. After all, the industrial boom, which can largely be explained by the relocation of labor-intensive production to these "low-wage countries," was based on the fact that, for comparable productivity, labor costs were often only ten to thirty percent of those in the EU. The other side of the coin was that the employees, with their cheap wages, could not afford the Western standard of living, which was now also considered "normal" in the ex-Comecon countries and to which they aspired.

The catch-up potential seemed enormous. Because in 1999, every German household had an average of 43,000 euros worth of knowledge.While many CEE countries were in debt to the tune of DM 300 a decade ago, private debt was practically zero. The banks now began to extend all kinds of retail loans to those employed in the flourishing production plants. Installment loans for consumer durables, mortgages, car leases and bank overdrafts have enabled these countries to achieve a respectable level of consumption despite insufficient incomes. At the same time, it made the CEE countries the growth pool of Europe, while Western European exporters were only too happy to meet the region’s material catch-up needs.

As a result, although per capita debt in the transition countries rose significantly in line with the availability of the respective credit products, it still lags far behind Western standards in all CEE countries today. For every Austrian, there are currently around 38.000 euros in personal loans, the current average in Hungary is only about 2.500 euros, and in Russia only about 350 euros.

However, it is now problematic that a good half of the loans were not granted in the respective national currencies, but in lower-interest euros or Swiss francs, so that the devaluation of the respective national currencies has made these loans significantly more expensive.

As is well known, the average income of these borrowers is far below Western European levels, but if you believe the Austrian banks, the payment morale in the region is currently still significantly better than in Austria or Germany. In addition, according to the banks, about 60 percent of these loans were covered by domestic deposits in each case, and high collateral was also generally required from the borrowers. Unlike the infamous U.S. Subprime mortgages, which were predominantly issued as so-called "non-recourse loans", where the borrower can fully discharge himself from his obligations by transferring ownership of the property, this practice is unknown in the CEE region, so that debtors are generally liable for their obligations with their entire assets.

Consequently, the banks are probably right in assuming that even in the event of a sovereign default in Ukraine, for example, private obligations could also be affected, but that even in an extreme case a total loss would not occur under any circumstances. Certainly, for many borrowers, monthly charges measured in local currency have risen sharply, and the rampant job losses will also make it impossible for many borrowers to meet their payment obligations. However, the consequences of private bankruptcy are highly negative in all countries, so that borrowers were at least strongly motivated not to part with their debts too lightly.

The problem could be found much more on a macro-oconomic level. Although the CEE region has developed into the European "workbench", the credit-financed purchases of consumer electronics, vehicles and industrial equipment have resulted in sustained negative trade balances. Until now, these deficits had been more than offset by foreign investment and remittances from Eastern Europeans employed in Western countries. Now, this flow of money has largely dried up, so that some of these countries may indeed be forced to at least introduce sovereign debt moratoria. However, the respective national debts are hardly in the banks’ books, but in the form of bonds in the portfolios of investors.

European package for Eastern European debt?

The British Telegraph quotes Stephen Jen, a financial expert at the U.S. Investment bank Morgan Stanley, as saying that Eastern Europe has a total foreign debt of 1.7 trillion U.S. Dollars, which is about one-third of the region’s national product. Of this, 400 million will fall due this year, which would be almost impossible to finance in view of the current situation on the credit markets. Since the current economic crisis seems to have a greater impact the closer production is to the basic material sector, industrial production in the countries concentrated in this sector has been allowed to fall even more sharply than in Western Europe. Servicing these debts through export earnings or domestic savings could therefore be completely ruled out, even if there were extremely drastic consumption cuts in the CEE region.

So, in fact, only foreign countries remain as a source of funding. At any rate, it is hardly conceivable at present that the foreign banks active in the region will be able to shoulder this sum on their own. After all, the banks are dependent on the international financial markets for their refinancing, which already view their old CEE exposures with a great deal of suspicion. Since the affected countries predominantly do not have the necessary resources and creditworthiness themselves, a "European solution" seems necessary. This was likely to cost the EU only a fraction of the cost of letting things take their course, given the extremely negative consequences of a CEE bankruptcy.

So far, the German government in the person of Peer Steinbruck, who last week brusquely rejected an initiative by the Austrian Finance Minister Josef Proll, has stood in the way of such a solution. However, Proll had peddled a so-called "bank rescue package" to the CEE countries and the EU lender countries in a relatively clueless manner, which could not have been overly clever. On the one hand, this was the first time he really got the Austrian banks talking, and on the other hand, Steinbruck is hardly so keen on Austrian banking secrecy that he would mobilize extensive tax funds to rescue mainly Austrian banks. Quite apart from the fact that the banks have earned billions in the region for years and are not yet in any serious danger, as the very good quarterly figures of Raiffeisen International, which were published ahead of schedule, have just shown.

What, on the other hand, could actually still become very problematic, apart from the existing debts, is above all the future financing of the economies of the CEE countries. While it is likely to have a positive macro-economic impact if consumers in the CEE region now hold back a little, the lack of financing for companies could have a catastrophic effect in the future. For now, this problem is alleviated by the fact that the slump in orders means that much less working capital is needed than a year ago. However, if the global economy were to pick up again, many companies could lack the necessary funds to resume production, which would have lasting negative consequences.

Austrian banks, at least, claim that they will not abandon their CEE customers in the future, but their funds alone are unlikely to be sufficient to finance any future upswing. The European Development Bank (EBRD) and the International Monetary Fund have a similar view and are now also calling for a bailout package of up to. Euros. However, this is not for the banks, but for the region, which could make a difference psychologically, at least from the German point of view.

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