Tim Gosling in Vienna -

Central and Eastern Europe fears a sharp cut in lending as the sovereign debt crisis takes its toll on Western Europe's banks. One of the biggest lenders in the region, Raiffeisen Bank International (RBI), is indeed pulling back in response to the "shock therapy" of the EU's capital ratio demands, but it hopes to balance that against the greater growth opportunities the region offers.

The European Bank for Reconstruction and Development said January 24 that deleveraging by western banks appears to have been underway since the autumn, meaning that contagion from the Eurozone crisis to the region has already begun. That's no surprise given that January 20 was the deadline for 31 major European banks to submit plans to comply with the demand to raise Tier 1 capital ratios to 9%.

Patrick Butler, who sits on the board of RBI, insists his bank will meet the demand, but it's clearly a difficult ask. "We have every intention of meeting the EU critieria by the deadline of June 30, but we are very unhappy that plans for a gradual increase in capital have been accelerated into an eight-month bracket. That's shock therapy, which is very negative for the economies of both Western Europe and CEE," Butler told bne in an interview before reports emerged on February 8 saying that RBI is mulling a €1bn rights issue to help it hit the target.

This rush to recapitalise risks driving economies into a recession for two reasons. "Firstly, the equity market knows that there's potentially a lot of equity to be issued if the window opens. Secondly, the worry is that the banks will reduce asset growth or even assets."

That said, the banker doesn't expect many of RBI's peers to struggle to meet the deadline. "It's an issue for many," he agrees, "but I suspect only a very modest number, if any, will fail. There are banks that have had difficulties, and some of them have had business in CEE, so people are making a shortcut connection between those two points."

Limited options

The options for raising the necessary capital are limited, but shrinking the balance sheet is one route RBI will have to take, which will inevitably slow lending in CEE. "It's not our strategy to simply reduce riskier assets, but it is a component - we do not intend to grow as fast as we have been," Butler says, stressing that it's not a major withdrawal from the region's credit markets, which would be counterproductive.

A second option for the sector is to dispose of assets, but in the current climate it would be tough to attract buyers for subsidiaries in less promising economies, whilst few will want to offload those in high-growth markets such as Poland or Turkey. Butler insists this is not in RBI's strategy. "We made over €1bn profit before tax in the first three-quarters of 2011 - an awful lot of it in CEE. We'd be cutting off our nose to spite our face were we to divest."

More positively, Butler suggests mid-January's improvement in market sentiment opens up a third option. "A week ago, I would have said that a lasting recovery in the equity markets seemed unlikely, but sentiment has changed. The market senses that the European Central Bank's effective quantitative easing, plus budgetary measures in various countries, will buy time. I now think we will see an equity rally, and given the relief that [the €7.5bn capital increase from] Uni- Credit is out of the way, we may see some European banks able to raise new capital."

With every little bit counting in the European sector's fight to find the €115bn it needs by the summer, Butler suggests further options. "We intend to do a number of securitisation deals, whilst the other route is retained earnings. We have a machine that retains hundreds of millions per annum - which represents Tier 1 capital, of course."

Another point of optimism is Butler's take on November's so-called "anti-Vienna initiative," which was the Austrian regulator's attempt to limit the funding that its banks channel to subsidiaries in CEE. He says no one has called round to talk to RBI about it. "My latest understanding is that it was a statement of intent, but not a binding measure. Nobody is enforcing it, and it may not be enforceable under EU legislation anyway."

He also suggests the measure is fundamentally flawed, a point apparently not lost on the international institutions currently attempting to build "Vienna 2.0" in a bid to protect and coordinate funding flows to and from CEE, just as the original "Vienna initiative" was set up to do in 2009. "I think it's important we measure everything with the same yardstick," opines Butler. "If the West expects CEE not to put up barriers to capital flows, then that should work both ways."

He claims that it would make little difference to RBI anyway. "The bulk of funding in all our subsidiaries comes from the local market, so I don't envisage major problems for us in any market," Butler says, although he suggests the wider banking sector in certain markets could face challenges, expressing "some concerns for Hungary... and to a lesser extent Ukraine."