CEE/CIS BANK SURVEY 2016: Foreign players look for niches after market bottoms out

CEE/CIS BANK SURVEY 2016: Foreign players look for niches after market bottoms out
Banks such as Erste are having to defend their market positions by making big investments in internet banking.
By Robert Anderson in Prague November 7, 2016

Most of Central and Eastern Europe’s banking markets have bottomed out and are now well on the road to recovery, after the markets’ overall return on equity (ROE) in 2015 sunk to the lowest level for a decade, falling even below Western European levels.

According to an Raiffeisen Bank International (RBI) report in June, in 2015 ROE in CEE (excluding Turkey and Eurasia) fell below 5%, while the Eurozone recorded around 6%. But in our own survey, based on first-half figures for this year, the best banks in the region are now able to rake in a ROE of well into double digits (the top banks in each country are ranked in our November magazine).

Central Europe was always performing better than Western Europe, and Southeast Europe is now over the worst of its non-performing loan (NPL) problems. Provisions there are being written back, sometimes after landmark sales of bad loan packages. Put together, the two regions recorded an ROE in 2015 of nearly 10%, according to RBI, close to their cost of capital.

The overall CEE figure in 2015 was again dragged down by Eastern Europe. Russian banks made a -0.15% return – the worst since the 1998-99 crisis, according to RBI – while Ukrainian banks were massively lossmaking.

The conflict in Ukraine and the sanctions on Russia, as well as falling oil prices, plunged both countries into recession, and have had a knock-on effect on the whole Eastern European and Eurasian region via falling export demand and remittances. Both Kazakhstan, Tajikistan, and particularly Azerbaijan have experienced a rash of bank failures triggered by currency depreciations and economic slowdowns.

However, both Ukraine and Russia are now emerging from this crisis, and the latter should be profitable this year. The aggregate profit of the sector may exceed the Central Bank of Russia forecast of RUB500bn ($7.9bn) in 2016, according to the central bank’s governor, Elvira Nabiullina.

Foreign banks are still making good money in Russia – averaging an ROE of 15-17% in 2015, according to RBI – but they are having to refine their strategy to focus on niches, as state-owned banks grow their market share. Banks such as RBI and Citigroup have been cutting back their branch networks, instead focusing on serving blue-chip corporates and high net worth individuals.

“We are even more confident that we have reached the bottom in Russia,” says Gunter Deuber, RBI’s chief economist. “RBI and UniCredit have shown that they can earn money in Russia even in troubling times.”

Too little, too late

Deleveraging may have come to an end in most of the region, yet for some foreign banks the recovery is coming too little, too late, and they are looking for the exit. Tougher European regulatory requirements (and investor expectations) on risk, debt, liquidity and capital, as well as the impact of continuing low interest rates and fierce competition on margins, mean the often meagre returns to be made in the region do not justify the perceived higher risks.

In Central Europe retail lending in particular has grown healthily, but not by enough to stop banks being over-liquid. Regulatory requirements have forced banks to keep money on deposit at the central bank and to invest in government paper, all carrying low interest rates. This has led to a competitive scramble to lend, with banks dropping rates and terms.

In Southeast Europe loan growth has been hampered by longstanding NPL problems dating back to the global financial crisis, particularly in Romania, Bulgaria, Slovenia and Croatia, in the last of which the sector remains unprofitable. “The workout of NPLs in Croatia has been much slower than in other neighbouring countries,” says Anna Lozmann of Standard & Poor’s, a rating agency.

“We need a little more in terms of profitability,” says Deuber about Southeast Europe. “Currently most banks are in a wait and see approach. The margins are not justifying the pure risk.”

So far, the trigger for the banks to pull back has been problems or changes in strategy at home. US banks such as Citigroup and GE Capital have led the exodus, which is expected to pick up speed next year as valuations improve.

Governments in Central and Southeast Europe have often given the banks a push in the back by imposing hefty bank taxes or penalties for past foreign currency lending. This has led to legal challenges, particularly in Croatia.

Rightwing populist governments in Hungary and Poland are also publicly following a policy of trying to increase local ownership of their banking sectors by pushing state-owned banks to go on acquisition sprees. “There is strong political pressure for the state actor to take over,” says Mateusz Toczyski, a partner in Denton’s Warsaw office and head of its European Banking and Finance practice. “The current government wants to re-Polonise the banking sector.”

In Hungary, following a landmark peace deal between Erste, the government and the European Bank for Reconstruction and Development in February 2015, bank taxes have been cut. Together with the fall in NPLs, this is making banks feel more optimistic, though corporate lending is still depressed. The sector should return to profit this year. “There is now a much more friendly political attitude,” says Lozmann of S&P, which raised its anchor rating for the sector to ‘bb’ in the summer.  “We don’t expect further punishment by the government”.

In Poland, the incoming government appears to have pulled back from initial plans to follow Budapest’s aggressive strategy, but banks remain wary. “It is still giving us some concerns on the political risks affecting the banking sector,” says Salla von Steinaecker of S&P.

In any case, the days of trying to build a big branch network on the universal banking model are over. “Running a universal banking model you need at least a market share of 10%-plus,” says Deuber.

Instead, banks are looking for niches – sometimes risky ones, such as credit cards and lending to small and medium-sized enterprises – and are cutting costs (and branches) in search of profits. “Banks are getting out of non-core businesses where there is little cross-selling opportunity,” says von Steinaecker.

But even banks that have built strong positions in very profitable markets – such as Erste, our retail bank of the year, in the Czech Republic and Slovakia – are struggling to cross-sell other banking products to their conservative clients.

They are also having to defend their market positions by making big investments in internet banking, to ward off aggressive local players and fintech companies, such as Worldcore, our fintech newcomer of the year. “The CE markets are rather sophisticated on e-banking,” says Deuber. “You need to invest to satisfy the client.”

And with tighter regulatory rules looming, life is not going to get any easier for the region’s banks.

“We would appreciate a stable regulatory environment, where parameters finally stay the same for at least two years,” Erste’s CEO Andreas Treichl told bne IntelliNews in an emailed comment. “Bankers are entrepreneurs that want to make business and concentrate on clients. But if you don’t know how your most important parameter, the core capital, has to look like next year, it’s hard to do so. Yet what Europe and its economy need right now are banks that are willing and able to grant loans.”