Jan Cienski in Warsaw -

For many years, the only contest in Polish banking was for second place, because the top spot in the rankings was the preserve of PKO BP, a state-owned behemoth with branches in almost every Polish town and village.

That changed in December, when the long-delayed merger between Poland's second largest bank, Pekao, and its third-largest, BPH, was finally consummated, creating the country's largest bank. Now the fight is on between PKO BP and Pekao for the title of banking market leader.

"We have more than a million new clients, many more good workers and we are cementing our number one position in corporate banking," says Jan Krzysztof Bielecki, Pekao's CEO.

Pekao, owned by Italy's UniCredit, has PLN122bn (€36bn) in assets, a 16% share of the market, and controls about 27% of the corporate banking market. In the first quarter of this year - the first timeframe in which Pekao and BPH functioned as one - the merged bank reported profits of PLN1.1bn. Those numbers are fractionally better than PKO BP's, where the state still retains 51% of the shares. With assets of PLN113bn, PKO BP has 15% of Poland's banking market, and in the first quarter it made a profit of PLN951m.

For now, the energetic Bielecki, a former Polish prime minister and current football fanatic, is devoting most of his time and energy to completing the digestion of BPH, formerly owned by Germany's HVB, which was acquired by UniCredit in 2005. The merger was plagued with problems: it ran afoul of the previous right-wing Polish government, which worried the combined entity would reduce competition in the banking sector. The European Commission became involved, launching an infringement procedure against Warsaw, arguing the government's hostility to the deal may have violated EU rules guaranteeing the free movement of capital.

In the face of these political obstacles, UniCredit was forced to compromise, agreeing to sell off 200 of BPH's 485 branches, while absorbing the corporate banking, investment funds and brokerage parts of BPH into Pekao. Pekao ended up taking about 1.3m clients, leaving the rump BPH, now being bought by GE Money of the US, with 650,000 clients. The process was fraught with difficulties. "In many peoples' minds, a merger is linked with marriage, but in our case this was more of a hostile divorce," says Bielecki. Many former BPH clients who have seen their accounts shifted to Pekao have groused about the change, but Bielecki maintains that only a tiny fraction have taken their business elsewhere.

While Bielecki deals with the after-effects of a merger tainted with political interference, PKO BP is also dealing with its own politically induced problems.

Interference

In the case of PKO BP, that means a new CEO. Jerzy Pruski took over the bank in May, ousting Rafal Juszczak. Juszczak had only been in charge of the bank for less than a year, but in that short time gave management an element of aggression missing in the past. "Changing management is going to mean a good few months of drift," worries a senior executive at the bank.

Pruski is closely allied with the current Civic Platform-led coalition government headed by Prime Minister Donald Tusk. Pruski quit as deputy governor of Poland's central bank, claiming he was unable to work with Slawomir Skrzypek, the bank's governor who is considered a supporter of Lech Kaczynski, Poland's president and a foe of Tusk. Skrzypek also had a brief turn at the helm of PKO before being forced to leave because he had no banking qualifications and experience, and so was unable to meet regulatory requirements to permanently take the top job. Because of the bank's size, it has long been considered a political prize, to be handed out to loyalists of whichever party happens to be in power.

Despite turmoil at the top, PKO has managed to produce respectable results. Before he left, Juszczak predicted that PKO could earn a record €1.2bn in profits this year. "It is possible that our net results could beat Pekao this year," he told reporters. "PKO is speeding along, but the current results don't fully reflect the bank's potential."

Pruski, who is more of an academic than a manager, plans to announce a new strategy for the bank in late June. But it's already clear that the two banks will do battle across the full range of banking services.

Best on offer

PKO BP has about a third of Poland's mortgage market and is continuing to eclipse Pekao, which refuses to give loans denominated in Swiss francs, increasingly popular at a time when the central bank is hiking rates to squelch inflation. Pekao has been underperforming the rest of the market when it comes to mortgages. Over the last year, PKO's credit portfolio grew by 29%, while Pekao's only expanded by 1.5%. "Market share losses are worrying," says Jiri Stanik, an analyst with Wood & Co, a Prague-based brokerage, in his examination of the Polish banking market.

Bielecki admits that sticking to zloty loans "has been an enormous loss," but he has no intention of pushing to change the policy because he worries about the risk posed by lending in a currency other than one that customers earn.

Despite some signs of a slowdown in the residential market, mortgages continue to grow. Polish banks last year issued PLN60bn in mortgages, 46% more than in 2006, according to the Polish Banking Association. In 2008, it expects mortgages to rise to about PLN68bn.

Both banks have been hit hard by the slump on the Warsaw Stock Exchange, which has cut into their brokerage fees and hammered their mutual funds. Pekao reported a 14% drop in fees due to mutual fund redemptions as customers flee the funds and put their money into bank deposits.

So far, Pekao has an edge in deposits, but PKO is nipping at its heels with an aggressive promotion of higher rate accounts. Pekao also leads in corporate banking, especially with larger firms, because of the advantages of being part of a pan-European network. It also plans to push harder to gain market share with small and medium-sized businesses, which have been a source of strength for PKO.

For Bielecki, the contest for primacy in Poland doesn't make much sense because Pekao is part of a much larger group, which dwarfs PKO on a European scale. "We aren't really looking at PKO," he says.

But if Pruski manages to replicate the hard-driving character of his predecessor, and avoids the political interference that has been a frequent danger for CEOs of his bank, he could well give Bielecki a run for his money for the title of Poland's largest bank.

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