The banking downturn in Central and Eastern Europe (CEE) is over, with profitability surging last year, according to the annual CEE Banking Report by Austrian lender Raiffeisen Bank International.
The de-risking and capital strengthening drive forced by the 2007-08 global financial crisis is largely over, and banks are now increasing their assets above GDP growth, while profitability is covering the cost of capital. In short, banking convergence, or catch-up with Western Europe, has returned, the lender announced.
Return on equity (ROE) across the CEE region (which for RBI does not include Turkey or Eurasia) more than doubled to 10.5%, well above the 5-6% achieved in the Eurozone. Eight of the 15 CEE markets are now covering their cost of capital, compared to four in 2015. Looking forward, the bank predicts an average of more than 10% ROE.
“All in all, the CEE region started to significantly outperform Western European banking profitability once again,” the report said. “Therefore, the year 2016 ended years of down-trending profitability in CEE banking.”
Large Western players in the region are making even higher profits than the average, around 12-14% ROE. This could reawaken interest in CEE banks, and lead to an end to foreign banks' retreat from the region in recent years. “From now on the appetite is there once again from foreign players,” Gunter Deuber, RBI’s chief economist, tells bne IntelliNews.
The market share of foreign lenders fell last year to the lowest level for a decade, mainly due to an increase in the market share of state-owned banks in Eastern Europe and growing local or state ownership in Central Europe, notably Poland and Hungary. But RBI expects this trend now to peter out.
In fact, the rebound in profits could have unwelcome repercussions if banks once again attract the attention of governments, Deuber says. “We must watch carefully how politicians and regulators react to the current situation. There could be certain claims on bank profits, for example in the Czech Republic and Hungary. This could be a problem for profitability going forward.”
The recovery was strongest in Russia, Romania and Hungary. Southeast Europe continued its solid rebound, while Central Europe has already been growing strongly for a few years, though RBI said the Polish market has begun to soften.
The fast recovery of the Russian market was the big surprise of last year, according to Deuber, with ROE bouncing back to 10% after just 2.5% in 2015, and assets growing by 15% across the Eastern European region led by Russia.
Western players in Russia maintained an ROE of 18%. “Foreign banks have shown they can operate in the niches,” Deuber says. “Now they have proved this for a second year.”
On aggregate, Ukraine was the only loss-making banking market in 2016, according to RBI, because of massive one-offs related to the nationalisation of PrivatBank. Non-performing loans (NPLs), at an average of 30% of total lending, remain a serious problem across the sector.
Deuber also highlights Belarus as a worry because of the “substantial increase” in the NPL ratio to 12%, and the overall contraction in lending.
Apart from Russia, one of the main drivers for the overall improvement in banking profitability was the faster than expected progress in restructuring NPLs, which have stabilised at 8% across the region. As well as workouts by banks themselves, sales of NPL bundles have taken off, particularly in Poland, Romania and Russia, enabling banks to write back provisions.
“Now it is reasonable and feasible to sell NPLS at acceptable prices for all parties,” says Deuber, pointing out that some buyers of distressed debt had been reluctant to go into CEE before.
Across the region banks have benefited from strong growth in loans, and especially deposits. Assets are now growing strongly in euro terms after two years of setbacks, with growth once again higher than in the Eurozone. Asset growth was 11% in 2016, above the post 2007-08 crisis average of 6-7% and last year’s Eurozone average of 2-3%. Overall credit growth was 8%, above the post-crisis average of 6% and the Eurozone’s 1% last year. The bank predicts 7% growth in lending in local currency terms in 2017-22, though slightly slower in the more mature Central European market.
Going forward, RBI predicts that the market should be buoyed by the promising macro-economic outlook for the region, boosting lending, particularly in the retail segment. “Strong macro momentum should support retail growth,” says Deuber. “There is still upside left on the banking side”.
Unlike before the global financial crisis, this growth should be more balanced, with more local financing, and less lending in foreign exchange and aggressive pursuit of market share. Loan/deposit ratios are already down to 86%, back to pre-boom levels.
The main problem for the banks now is what to do with all these deposits at a time when net interest margins are very narrow and are not expected to improve fast. “Banks are over liquid,” says Deuber. “They cannot accumulate deposits indefinitely.”
One way to use retail deposits, he said, was to invest in banks’ digital footprint, which can create new revenues and cut costs dramatically. “The CEE region is an ideal ‘testing field’ for cross-border digital banking solutions, as the size of some CEE banking markets is comparably small and the users seem to be quite open to accept new products and services as well as innovative retail and communications channels,” the RBI report said.