Jan Cienski in Warsaw -

The first signs of a downturn in the Polish banking sector arrived in the form of gloomy third-quarter earnings reports - an indication that the crisis buffeting the rest of the EU is beginning to make itself felt in Poland.

PKO BP, the country's largest bank, saw its third-quarter net earnings come in at PLN921m (€222m), a 9% fall over the same period a year earlier, largely because of a fall in new loans and an increase in troubled credits. Another bank, Getbank, which had been an aggressive mortgage lender in the boom times before the crisis, reported a net profit of just PLN61m, down 35% compared with the same period a year earlier - due to higher-than-expected net provisioning requirements tied to a weakening of asset quality, mainly mortgage loans. "We seem to be entering a period of slower growth," says Zbigniew Jagiello, CEO of PKO BP, a bank controlled by the state treasury.

The estimates are that the banking sector's overall profits will be slightly lower this year than last, when banks earned a record PLN15.7bn. As a result, a series of mid-sized banks are laying off workers - about 2,500 employees out of a sector-wide workforce of about 125,000 have lost their jobs and more branch closures and layoffs are planned.

Problems home and away

Poland's banks face both foreign and domestic challenges.

On the foreign side, there are worries that the two-thirds of the sector owned by foreign institutions will be negatively affected by the ongoing crisis in the Eurozone and reduce liquidity support to Polish affiliates. According to the Vienna Initiative, which aims to prevent a disorderly deleveraging from the CEE region that would imperil banking systems and economies, says cumulative funding withdrawal from the region stands at 4% of GDP since mid-2011, and the rate picked up in the second quarter of this year from the previous quarter. "The foreign ownership of the major banks in Poland exposes the system to the euro area turmoil and has the potential to act as a transmission channel for greater volatility and deleveraging trends in the Polish market," notes Moody's Investors Service, the rating agency.

However, Poland's banking sector is relatively well funded, with a loan/deposit ratio of about 116%. With rapidly rising deposits, there is little danger of a credit crunch even in the event of a funding cut-off.

Polish banks are also insulated because they have generally been quite profitable. When Germany's Commerzbank announced that it was retrenching in the CEE, it made a specific point of excluding its Polish affiliate BRE Bank from any cutbacks. "The west European banks are really keen on keeping their franchises," says Gunter Deuber, banking analyst for Raiffeisen Research. "As long as the subsidiaries are profitable, no one wants to sell."

What sales have happened have been prompted by troubles at the parent banks, such as the 2011 sale of Bank Zachodni WBK by Allied Irish Banks and this year's sale of Kredyt Bank by Belgium's KBC, both bought by Spain's Santander to create the country's third-largest banking group.

On the domestic side, banks are still battling the hangover from the real estate boom, when mortgages denominated in foreign currency, particularly Swiss francs, were very popular. However, when the crisis hit in 2009 and the zloty dropped sharply against the franc and the euro, banks and borrowers saw that this form of lending was a lot riskier than they had expected and very few new such mortgages are being offered. "They have become a really marginal product," says Artur Szeski of Fitch Ratings.

In all about 57% of all mortgage loans are denominated in foreign currencies, down from 65% at the end of 2009. However, such loans only form about 22% of the overall loan portfolio. "That is too small to create much of a danger to the stability of the banking sector," says Jacek Rostowski, the finance minister.

The number of problem loans is slowly inching up, hitting 4.7% of total loans this September, up from 3.7% at the end of 2009, and the number of bad loans is expected to grow as the economy slows. While the level of bad mortgage loans is still low, at only 2.6%, there are growing worries about the construction sector - accounting for about a fifth of all corporate lending.

Polish construction companies thought that they would do very well out of the infrastructure boom fuelled by EU structural funds, and banks were happy to lend. However, many firms engaged in cutthroat competition to get contracts, which the government has been unwilling to renegotiate, and large swaths of the sector are now facing bankruptcy as it becomes clear they cannot turn a profit on their projects. "Non-performing loan problems are coming from the real estate market and from the construction sector," says Szeski.

As the economy slows, the Polish Financial Supervision Authority, the banking sector regulator, has eased some of the lending restrictions it imposed after the first wave of the crisis, hoping to avoid a dramatic slowdown that could harm the economy. However, Jagiello expects new lending to grow at only about 5-6%, lower than the double-digit rates that were common a few years ago, which means the sector is unlikely to see the record-breaking profits of last year.