Robert Anderson in London -

Once Austria's RZB wins the approval of shareholders in July to merge with its affiliate Raiffeisen International, it can begin to unlock "enormous synergies," according to Patrick Butler, RZB's board member for financial institutions and investment banking.

That optimism hasn't been universally shared; when the announcement of the merger of the unlisted Austrian savings bank with its international arm was announced in March, it pushed Raiffeisen International's share price down 17% in a week. Raiffeisen shareholders feared that the merger with its parent - which currently holds 70% - would condemn the bank to the lower growth of the Austrian banking market, rather than the much higher rates forecast in the 17 countries of Central and Eastern Europe where Raiffeisen has operations.

The timing of the announcement, amid continuing worries about the health of emerging Europe and the overall banking market, also sparked speculation that RZB needed to raise equity, which would dilute existing shareholders.

RZB believes shareholders are beginning to understand the potential benefits of combining two banks with "different processes, cultures and products." Once the merger takes effect this autumn, the bank's ability to draw funding will improve and operations can be standardised or centralised where it is most efficient. "A lot of these are unnecessary differences," says Butler, a British banker who has been working for Austrian banks on and off for 20 years. "There are enormous synergies if we make the processes more uniform. Why should we have 15 banks trading in the dollar/euro?"

Better days

RZB has also played down the urgency of its capital raising, which will be required both to repay €1.75bn lent by the Austrian government during the financial crisis, and to meet the new tighter capital rules imposed under the Basel III international banking guidelines. Nevertheless, RZB's Tier I capital adequacy ratio will only be 9.3% after the merger, which doesn't give it much room for manoeuvre. "In years to come we will raise capital from equity markets," says Mr Butler.

The bank believes that won't be a problem, as investors are once again focusing on the faster long-term growth possibilities in CEE, with Raiffeisen International's share price already back at its 2005 flotation level. Worries over the health of the region's banking sector have been shown to be overdone - because banks there were well capitalised and did traditional banking business - and even the crisis in the Eurozone sparked by Greece's debt problems has so far had little impact. "The Greek crisis demonstrated how positive the numbers are in Eastern Europe," Butler points out.

The growth of banks' non-performing loans is "clearly slowing down" - Raiffeisen International's on a pro forma basis were 7.7% of all loans at the end of March - and will probably hit their peak towards the end of this year, he adds. At the same time, provisioning for problem loans will be much lower this year than last, and next year some will start to be written back, boosting banks' profits.

He remains concerned, however, about two of Raiffeisen's eastern operations. "Our big worries are Hungary and Ukraine, particularly Ukraine," he says, though he adds that President Viktor Yanukovych has brought greater political stability and with it faster economic recovery. Hungary remains a problem because of the proportion of lending in foreign currencies and the "jury is still out" on the new government there.

Looking longer term, the outlook for the region is improving, according to analysts, though banks have yet to see it reflected in loan demand. "We are seeing recovery without consumption and only limited corporate investment," says Debora Revoltella, head of CEE strategic analysis at UniCredit. "For banks this is not ideal, because there is no demand for lending."

Butler admits to some frustration. "Demand is slower than we anticipated," he says, pointing out that the bank is still doing a lot of repo business and short-term lending to other financial institutions when it would like to expand corporate and retail lending.

But he insists that the region still holds a lot of promise. "Growth will not be as high as the past, but it will still be significantly higher than the Eurozone."

Mergers and acquisition in the banking sector could also start to pick up as the global economic crisis eases, according to Revoltella, as weakened local banks or foreign banks with domestic problems decide to sell up when valuation multiples recover. Parex Banka, which was taken over by the Latvia government, and BZ WBK in Poland, owned by Ireland's AIB, are already up for sale.

RZB, though, is unlikely to take part in any M&A, but will focus on making its internal merger work. "Now is the time to build on what we have," says Butler. "Major acquisitions are not on the menu."