Dominic Swire in Prague -

While the shockwaves of last year's credit crunch are still being felt across the globe, the banking sector in Southeast Europe has not only been left virtually unscathed, it is looking at a bright future, according to a recent report by Vienna-based Erste Bank.

Far from being an impediment, the lack of development in the Southeast European banking sector has not only acted as a buffer to the recent turmoil seen across the financial world, it also means huge potential for growth. However, rising funding costs and a high level of exposure to foreign exchange markets could spell potential problems, says the report.

The study, entitled "SEE Banks - Boom or Bust?," focuses on the banking markets in Albania, Bosnia & Herzegovina, Bulgaria, Croatia, Montenegro, Romania and Serbia (including Kosovo). The report found that, while sentiment in the global banking sector remains low in the wake of last year's credit crisis, banks in Southeast Europe have remained relatively unscathed because none of them have been involved in any sub-prime-related investments. As a result, unlike many of their counterparts in the US and Western Europe, the Balkan banks have not had to write off any assets.

On the contrary, the report points out that confidence has actually been growing in many Southeast European countries due to the increased legal and political security many countries in the region are introducing as part of EU accession reforms. The resulting environment has attracted many foreign-owned banks, which now account for the vast majority of banking assets in the region. The arrival of these banks has not only contributed to the boost in confidence, they also provide a competitive benchmark for the progression of domestically-owned banks. "The entrance of foreign players usually has a very positive effect on confidence in the banking market, which can already be seen in Ukraine, Bulgaria and Bosnia & Herzegovina," reads the report.

Every silver lining has a cloud

However, the report warns that banks in the region have not got off completely scot-free following the credit crunch. Many are now experiencing problems from the global squeeze in liquidity, meaning a higher cost of funding and difficulty in securing asset growth at a reasonable price. In light of this, the Erste report focuses attention on loan/deposit ratios and finds a wide range of figures ranging from 61% in Albania to over 100% in Croatia, Serbia and Bosnia Herzegovina. Romania's loan deposit ratio rocketed to 122% in 2007, as it was unable to fund its strong loan growth with deposits. Equity capital was only up by a moderate 23% in comparison, meaning that wholesale funding from other banks and debt instruments grew in importance in 2007 and is likely to rise even more in 2008 at a higher cost.

Nevertheless, the growth potential of the banking sector in the region is huge, not least because of low levels of banking penetration. Although many people in the region are said to believe piggy banks are safer than actual banks, Erste's report says the increased confidence in financial institutions will gradually change this tendency. "While the deposits are already at a relatively high level in countries like the Czech Republic and Croatia, in the emerging banking markets, a lot of money is still stored in piggy banks. We expect the commercial banks to continue to replace piggy banks as confidence in the banking market rises," says the report.

Erste also cites loan growth as a source of huge potential in the region over the next few years. The main drivers within this sector being mortgage and consumer loans - a result of decreasing unemployment rates, rising GDP per capita and subsequently growing demand for consumer goods and housing, says the report.

Bulgaria and Romania showed particularly impressive year on year loan growth of 67% and 64% respectively. One of the main reasons for this was a more than 80% increase of foreign exchange lending driven by a cheaper euro and Swiss franc. "As a result, Bulgaria and Romania are heavily exposed to FX loans (greater than 50% of total loans), one of the highest exposures in Central and Eastern Europe. Significantly devaluing local currencies would therefore worry borrowers and bankers," warns the report.

Yet despite these worries the report is generally optimistic that the Southeast European countries can rise to the challenges and take advantage of their emerging growth potential for years to come. "Overall, we expect all Central and East European countries to use the catch-up potential they have, resulting in above-average growth rates for more than 10 years."

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