Nicholas Watson in Prague -

On June 16, the Czech central bank published the results of its stress tests on the country's financial institutions, which showed the sector to be pretty resilient. To a greater or lesser degree, that seems to be the case for the other three "Visegrad" countries of Central Europe.

The Czech National Bank ran three different stress tests: a baseline scenario of "Europe in recession," which is consistent with its current forecast of a 2.4% contraction of GDP in 2009; "market nervousness," which sees a sharper drop in GDP of minus 3.9% in 2009 and a depreciation in the Czech crown to 30 against the euro by mid-2009; and "economic depression," with a sharp 6% contraction in GDP in 2009. The biggest stress to the Czech financial system came under the "market nervousness" scenario, which would require capital injections into the financial system of around CZK23bn, or 0.6% of GDP.

"The Czech banking sector seems to be relatively resilient owing to its sound position before the start of the financial crisis," says Jaromir Sindel of Citigroup Global Markets. "The relatively sound position of the banking sector reflects relatively low balance sheet risks... [and] these partly reflect the fact that the bad loans in the Czech banking sector were transferred to the Consolidation Bank after the banking crisis in 1998 and before the privatisation of key banks to foreign owners."

While there are broad similarities between the banking systems of the four Central European countries (CE4) - which also include Poland, Slovakia and Hungary - analysts argue it will be the individual operating environments that distinguishes what happens in each as the crisis plays itself out. "The downturn is likely to affect all CE4 countries, but the channels of impact could be different," says Irakli Pipia, an analyst with Moody's Investors Service. "The operating environment, it's the key factor, because the banks are animals living in their operating environment, you cannot divorce them from that."

In terms of the similarities, the banking systems are all part of the EU club and enjoy the stability that that brings; they have limited exposure to high-risk international banking activities; they are principally domestic players (except for Hungary's OTP Bank); and there's a high degree of foreign ownership. On the negative side, the banks have unseasoned loan portfolios and untested risk management. "But even so, we think that the operating and regulatory environment is better and more mature than compared to that in the CIS and Southeast Europe," says Pipia.

Case by case

The Czech banking system is arguably the strongest of the CE4 countries, with the best loan-to-deposit ratios in the region. Even so, the banks are not without their weaknesses. For example, they have a heavy reliance on interest rate income, which means they are far more exposed to the compression of net interest margins, and they are limited in the diversification of their revenues.

For Slovak banks, the biggest problem going forward is their high exposure to cyclical industries, especially the car industry. Last year Slovakia produced 591,000 vehicles - the highest per capita car production in the world. But this year output is likely to drop below 500,000 and won't grow again until 2011, predicts Global Insight. As a result, unemployment has shot up to 10.5% from 8.7% at the end of 2008, while the economy contracted at an annual rate of 5.4% in the first quarter. This means a contraction in corporate and household deposits.

However, the country's membership of the euro since the start of the year has been a good stabilising factor and there's good system-wide liquidity. "A systemic banking crisis is very unlikely," reckons François Lecavalier, regional director in Bratislava for the European Bank for Reconstruction and Development.

Poland's economy is probably the strongest in the region, with Slawomir Skrzypek, the governor of Poland's central bank, telling bne recently that he thinks projections by the European Commission of a 1.4% contraction in the Polish economy this year are too gloomy; rather he expects a positive rate of growth in 2009. Even so, the Polish banking system has some particular quirks that bring extra risks.

Poland is relatively less over-banked than in the other three countries, so the banks pursued aggressive expansionist policies, especially during the first three quarters of 2008 before the crisis hit in the autumn. This headlong growth inevitably resulted in a relaxation of lending standards, leading to the region's highest loan-to-value (LTV) ratios - a measure of the riskiness of a mortgage - something that has been exacerbated by the preponderance of foreign-currency mortgages. Profitability has been further hit by heated competition for deposits, as well as allowing Polish companies to foolishly experiment with foreign-exchange options, which backfired spectacularly when the zloty reversed its relentless march up against the euro and fell around 30% over the past year.

On June 17, Moody's downgraded the ratings of five Polish banks: PKO BP, Pekao, Bank Zachodni WBK, Bank Gospodarki Zywnosciowej and Bank Handlowy, explaining the deterioration in the operating environment is putting pressure on the banks' standalone creditworthiness.

Hungary has by far the worst operating environment for banks - the economy has been in a prolonged recession and it was the first country in Central and Eastern Europe to go cap in hand to the International Monetary Fund - and, as such, its banking system is under the most pressure.

Of particular concern is the large share of foreign-currency lending in the banks' loan portfolios. By some estimates, over 90% of all new loans to Hungarian households in 2008 were made in foreign currencies such as euros, Swiss francs or dollars, meaning that over half of all lending to Hungarian residents is denominated in foreign currency, which translates into something like €6.5bn in forex housing loans. "Tight liquidity was a feature of the Hungarian system throughout 2008, and because of the forex exposure, it makes the banks dependent on their foreign parent even more," says Pipia.

However, while the stats look bad, Pipia notes that, so far at least, bank losses from mortgages remains low. "There's low LTV lending and high mortgage discipline," he says.

Send comments to The Editor