BLACK SEA BLOG: Is Romania an interest-rate haven for foreigners?

By bne IntelliNews September 23, 2008

Bogdan Preda in Bucharest -

Here's something of a Romanian paradox: foreign clients of Romanian banks are cashing in on higher interest rates on their deposits than the banks themselves can afford to get from the Romanian central bank when borrowing at benchmark-rate levels. And also considerably higher than both the Romanian annual inflation rate target and forecast.

Not strange enough? Well, here's the even more interesting part: foreign investors with deposits with Romanian banks made almost 10 times more money in July this year than in the same month of 2007 on interest rate payments. In numbers, that's the equivalent of €863m compared with the €88m of a year ago. And non-resident clients' deposits at Romanian banks stood at the equivalent of €5.8bn in July this year, more than double the €2.37bn in July 2007.

These findings are not the result of some investigation; they're revealed in data supplied by the National Bank of Romania and published by the Ziarul Financiar daily on September 15.

Let's examine how attractive those interest rates are that are sucking in such foreign money into local currency bank accounts. In a country whose central bank increased the benchmark rate to 10.25% to fight inflation, commercial banks are paying interest rates close to and in some cases even higher than 11% on leu deposits made by foreigners. Consider also that the National Bank of Romania targets an annual inflation rate of just 4%, plus or minus one percentage point, although its governor, Mugur Isarescu, predicted in August that inflation would slow to no less than 6.6% by year-end.

All of this shows that some Romanian banks are prepared to offer foreigners annual interest rates on leu deposits at almost double the inflation rate target - or even forecast - for this year. That's apparently more than enough to protect them from the swings in the exchange rate of the leu against the euro.

There's more to this where the subsidiaries of foreign banks in Romania are concerned: given that these bank's shareholders, hit by the global credit crunch, can no longer offer the foreign-currency cash to satisfy domestic demand for hard currency loans, those subsidiaries are attracting deposits from abroad in euros and pay annual interest rates of 5.5% and even as high as 6%. That's quite a nice deal, and has become one of the best in the EU for foreign depositors who would otherwise see not much more than 4% if they otherwise put their money in bank accounts back home.

But why is all this happening? And for how long can it continue?

In leu of lending

There are several reasons behind this phenomenon, and for the time being they seem to work nicely together. The most important of them is that Romanian banks have managed to avoid putting cash into compulsory reserves that are required by the central bank. That's because the central bank's regulations stipulate that if leu-denominated deposits mature in more than two years, then banks are no longer obliged to pile up compulsory cash reserves making up 20% of the deposits.

With more cash on their hands, banks are keeping pace with the lending frenzy in Romania, which the central bank is trying to limit to cap consumer growth and the subsequent upward pressure on inflation.

Amid fierce competition, in order to secure the cash they would later lend, banks either resort to refinancing operations by borrowing from the central bank, or perform some type of cross-swap engineering by exchanging their leu currency against euros with either a partner or parent bank abroad. Then the lei obtained that way goes into accounts at the same banks in Romania to pay those rosy interest rates.

A big outstanding question to all this is, why aren't Romanians benefiting from the same interest rates on deposits? The answer to that is that Romanians are predominantly spenders or investors rather than savers these days. Then again, why would banks in a market with such a hunger for borrowing give Romanians the opportunity to block their money in deposits rather than borrow it at higher interest rates?

Why hasn't the central bank changed its regulations in order to stop such schemes, which some of its officials claim will eventually cause more trouble with inflation and maybe even result in a homegrown credit crunch?

The central bank has a long history of claiming it wants to encourage leu deposits and even loans, versus those in euros. So, for as long as such operations don't exceed the levels where they might put tremendous pressure on consumer prices, make its benchmark rate mechanism less efficient, or cause major swings in the leu's exchange rate against the euro, one can assume this will continue.

For now, the central bank is worried that deposits in euros will follow exactly the same pattern, because compulsory reserves must make up 40% of total deposits by foreigners in Romanian banks, regardless of their maturity, but also given the scarce resources abroad.

Thus far, the central bank hasn't openly characterized such goings-on as "engineering," as it usually does when it wants to send what its Governor Mugur Isarescu enjoys calling a "constructive ambiguity" message across the market. That means the lack of message itself can so far be considered a case of ambiguity. Whether it will be constructive or destructive towards the banks' efforts to step up lending, that's still too early to say.

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BLACK SEA BLOG: Is Romania an interest-rate haven for foreigners?

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