There is positive news for all Central and Eastern Europe (CEE) commercial bankers, market observers and investment bankers. The fresh 2020 CEE Banking Report by Raiffeisen Research, an important source of opinion and information, has arrived and will be published today. And much more important is, of course, that the business prospects in the short term are not as bad as expected.
This crisis is unique. But that means the medium-term consequences of this crisis are probably unique as well.
A strong starting position helps
CEE banking markets enter the coronavirus (COVID-19) crisis on a solid footing, having reached record profitability in nominal terms in 2019, with an average Return on Equity in CEE at 15%.
We estimate the 2019 CEE banking profit pool at €47bn, thereof €13.6bn in Central European (CE) and Southeastern European (SEE) banking markets and €34bn accumulated in Eastern European markets (Russia, Ukraine, Belarus).
Non-performing loan (NLP) ratios reach multi-year lows in CE/SEE year-end 2019. The NPL ratio in CE reached a value of just under 5% at the end of 2019, in the CE-3 markets (Hungary, Slovakia, Czech Republic) even a remarkable 2.5%. In the SEE region, the NPL ratio was 5.9% at the end of 2019. This means that this ratio reached values close to the levels seen prior to the 2008/2009 Global Financial Crisis.
Crisis, crisis, but credit volume is rising much more strongly than in previous crises
Credit growth in CEE markets in the first half of 2020 was much stronger than in a "classic" macroeconomic and/or macro-financial crisis. This development reflects a strong turnaround after the first lockdown phase and above all in new retail business, which came to a virtual standstill during the lockdown.
Lending in some CE/SEE countries has been much more robust than expected. As in Western Europe, this is particularly true for residential real estate lending (e.g. in the Czech Republic, Slovakia or Romania, Croatia and Russia). Lending was supported by ongoing support and subsidy programmes and the rapid reduction of systemic capital buffers, additional capital buffers and/or the removal of micro- or macro-prudential regulations/tightening measures in many countries (e.g. Poland, Czech Republic, Slovakia, Bulgaria).
The reduction of bank taxation in Romania at the beginning of the year 2020 also had a positive effect. Not to forget that the special bank taxation schemes in Hungary introduced in 2020 has been rather bank-friendly from a mid- to long-term perspective.
Currently, credit growth in CE/SEE is in the range of 5-7% year on year on average. In some markets, such as Hungary, Serbia or perhaps Albania, even double-digit (!) credit growth rates (in local currency) are possible this year. The same may apply to the Russian market.
By comparison, previous crisis years in CEE were characterised by negative values or credit growth rates of 2-4% maximum.
It goes without saying that courageous support measures of a fiscal, monetary and regulatory nature have made the COVID-19 hit very manageable so far. After all, in this crisis we expect a fiscal impulse of 5-10% of GDP in CE/SEE, whereas in the Global Financial Crisis it has averaged around 3% of GDP – often followed by a rapid pro-cyclical cut.
Unemployment rates should therefore also rise less than in the aftermath of the Global Financial Crisis of 2008. On top of fiscal support liquidity support, regulatory forbearance and capital relief measures had been implemented in a swift and pragmatic way. This is positive news, as it was often feared that additional capital buffers won’t be cut in a bold and timely manner in crisis times.
Short-term crisis impacts manageable, substantial medium-term challenges
The short-term crisis impact is manageable due to a substantial degree of accumulated resilience. Foreign currency lending is less widespread in the region (excepting Belarus). The share of FCY loans in the CEE region declined once again significantly in 2019, bringing it close to 10-20% of the total loan portfolio in many of the CE countries and also in Russia.
In the SEE region and Ukraine plus Belarus, the figure is still 30-40%. However, with the exception of Belarus, the share of FCY loans is some 20 percentage points lower in all CE/SEE countries and Ukraine than at the beginning of Global Financial Crisis. Moreover, overall lending strategies had been prudent, and risk disciplined. Sectorial overheating tendencies were counteracted with foresight (e.g. in the Czech Republic, Slovakia, Romania and Russia).
Asset quality deterioration remained modest so far, with NPL increases by 10-50 basis points up to now. Nevertheless, we expect NPL ratios in the CE/SEE region to rise to a maximum of between 4-8% in the CE region and 7-10% in the SEE region. This would mean that the increases in the SEE region in particular would be much less dramatic than ten years ago.
In CE, the increase in the aggregate could be as strong as ten years ago, but much flatter this time than in the exceptional case of Hungary (where the NPL ratio from 2011-2015 was in the double-digit range). Overall, the imminent asset quality deterioration, especially in CE/SEE, should be less dramatic for a number of reasons (no excessive lending in the past, experience and appetite of distressed debt investors in the region, improved NPL handling frameworks), and above all flatter over time. We see the bulk of the expected NPL rise starting in 2021 until the end of the year and possibly still in H1 2022. Much will also depend on how quickly moratoria finally expire, how tax reliefs are treated going forward and at the same time when and if the fiscal impulses also take effect. The second wave of COVID-19 currently unfolding is inducing additional risks to retail and SME portfolios.
Elevated profitability and earnings pressure in Central and Southeast Europe, Russia and Ukraine as hedges for some Western CEE banks
The biggest mid-term challenges we are foreseeing are on the interest rate front. We arrived at rock-bottom interest rates in CEE in 2020, while this situation may at least stay with us in going into 2022.
In CE/SEE the interest rate landscape is nowadays much more challenging than in Russia or Ukraine and closer to the situation we are having in Western Europe. It goes without saying that clients in CE/SEE are nowadays clearly shifting from long-term deposits to demand deposits. Moratoria and credit holidays will also contribute to a decline in interest income. On some markets like Croatia and Bulgaria euro area entry (prospects) will eat into profitability as well. Mid-term we see some 10-15% of the current local banking sector profit pool at risk in both countries. On those two markets in particular and more general in the region the only way out of this situation is scale and consolidation.
Overall, we expect a profitability drop by 30-50% in 2020 and 2021 compared to a non-COVID scenario. The profitability drops in the CE/SEE markets could be at the higher end of this range.
For 2020 and 2021, we continue to expect return on equity to be in the single-digit range of 4-9% in most CE/SEE markets, with possibly more downside risks in 2021 than in 2020. Overall, a low double-digit RoE in CEE banking would be still possibly feasible in 2020 and 2021, but only when and if the EE markets and Russia continue to perform.
The profitability situation in the EE region was and is extremely pleasing with a RoE of 18% – the highest value since 2016 – in 2019 driven mainly by the banking market in Russia and Ukraine (RoE of 19.6% and 34% in 2019 respectively).
In the first half of 2020, return on equity was still around 15% or moderately below the previous year's figures (~14% in Russia, ~26% in Ukraine). In this respect, we believe that a double-digit RoE is possible here in 2020 and that the positive earnings differential between the EE and CE/SEE region could remain at around 9-10 percentage points. In this respect, the EE region could once again become a major revenue driver for some leading Western CEE banks in 2020, as it was in 2011-2013, when the banking sectors of the CE/SEE region suffered from the double-dip recession in the context of the euro area crisis, with a single-digit RoE, while the RoE in the EE region remained double-digit.
During the Global Financial Crisis or the Russia/Ukraine crisis, earnings ratios naturally turned in favour of the CE/SEE banking sectors. Overall, the sketched earnings patterns show, that diversification across the whole CEE region remains a viable business strategy. Moreover, one has to stress that unconventional monetary policy measures in CE/SEE have not yet achieved such market-distorting effects or dimensions like in Western Europe and are not expected to achieve them, which is why the yield curves are still steeper here.
Belarus risks manageable
Macroeconomic and banking sector challenges are definitely on the rise in Belarus – a market that was also profitable in times when other markets were in red territory in the past. However, we do not think that the challenging political and economic situation in Belarus could have a material impact on the profitability of both large Western European CEE banks (overall and in the EE region) and large Russian banks, in terms of negative earnings ratios. For Western banks, Belarus is of about the same importance as Albania, while exposures to countries such as Bosnia, Slovenia or Ukraine are twice or three times as high. And also, for Russian banks (with a market share of about 30% in Belarus), the exposures are not material or are below 1% of the domestic market exposure.
A lot of balancing acts for politicians, regulators and banks ahead
At the policy and regulatory level, it will be crucial in the coming 12-18 months to find meaningful co-ordinated solutions to important issues such as moratoria, the expiry of moratoria, tax deferrals and home/host-country regulatory issues.
The same applies at political level to national fiscal and/or supranational support programmes (e.g. with regards to the potential extension of support programmes supported by the EU's SURE initiative).
Curtailing the regulatory reliefs comprises another important question, which calls for precise timing and proper co-ordination with other (fiscal) policy measures. Indeed, delaying the recognition of banks’ credit losses for too long inhibits the accurate supervisory assessment of systemic risks, while lifting the forbearance early might threaten a credit crunch. It will require deft action by authorities to navigate these confines.
Another key question will be is how the authorities manage to accommodate the inevitable step-up in government borrowings, so they do not crowd out the much-needed credit supply to the real economy. Against this backdrop, one can reasonably assume an increase in banks’ exposure to sovereign risk.
Moreover, banks will have to continue to invest. Customers are currently re-evaluating their approach to banking services and are much more open to digital offers. This implies a further reorientation of the branch networks plus investments. In this context of digitalisation, we would like to point out once again the particularly competitive situation on the Russian market. Competition from neo-banks in the EU banking markets in CE/SEE will certainly increase massively in the coming years in view of the previously outlined increased digital affinity of many customers. Here, it will be important for the leading CEE banks to offer similar services in terms of customer experience and at the same time achieve economies of scale. We also see the potential for established CEE banks to win back customers and market shares from FinTechs and challenger banks, as the lending business is regaining importance alongside payment transactions. In addition, some banks may take the opportunity to acquire customers and technology from FinTechs now operating under more difficult market conditions.