Scott Bugie

1
World Bank ConferenceThe Financial Sector
Post-Crisis Challenges and Vulnerabilities
Eastern Europe, Russia and Central Asia

• Scott Bugie
• Managing Director, Financial Services Ratings
• 33 (0)1.44.20.66.80
• scott_bugie_at_standardandpoors.com

Washington, D.C. April 26, 2005
2
Global View of Emerging Market Banks

• Broadly speaking, macroeconomic environment and
  sectoral infrastructure have improved
• Likelihood of future banking crises has receded
• Certain banking systems remain vulnerable
• Key question Is the improvement secular or
  cyclical?

3
FDI and Reduced Corporate Leverage Drive
Improvement in Credit Profile of EM Banks

• Foreign Direct Investment
• Accelerated banking and securities reforms
• Brought much-needed banking know-how and capital
• Deepened globalization of world financial sector
• Promoted spread of best practices in bank
  supervision and risk management (although much
  work remains)
• Reduced Coporate Leverage
• Asian corporates hit by 1997-1998 crisis
  deleveraged over past several years and reduced
  industrial overcapacity (that led to crisis)
• Certain governments set up SPVs to purchase bad
  assets from troubled banks to facilitate
  restructuring
• Mexico, Turkey, and Brazil have lower levels of
  debt to GDP in 2004 than at the end of the 1990s

4
Global Ranking of Emerging Market Banking Systems
by Industry and Economic Risk
For comparison purposes Standard Poors
classifies these countries as mature markets
5
Over Past Five Years, Russian Bank
Creditworthiness Lags Sovereign
6
Russian Banking Market Turbulence inSummer
2004Underlying Causes

• Low confidence of households and corporates in
  Russian banks
• Interbank and Veksel (promissory notes) markets
  highly segmented, volatile, shallow
• Prevalence of Financial Industrial Groups (FIGs)
  maintains mistrust
• Mismatch between long-term assets and short-term
  liabilities
• Concentrations in funding
• Downturn in Russian securities markets (starting
  April 04)
• CBRs policy to clean-up banking sector, with
  policy of withdrawing licenses

7
Russian Bank FailuresMay August 2004
Bank name Date of license withdrawal Total assets mid-2004
Sodbusinessbank May 13, 2004 245 mln
Novocherkassky Gorodskoy Bank May 28, 2004 N.A.
Kredittrust Bank July 24, 2004 234 mln
Guta Bank 1,224 mln
Promeximbank July 29, 2004 59 mln
Moszhylstroybank July 29, 2004 52 mln
Commercial Savings Bank July 29, 2004 N/A
RIKOM Commercial Bank July 29, 2004 N/A
Dialog-Optim Bank August 10, 2004 286 mln
Bank Paveletskiy August 12, 2004 134 mln
Operations suspended in July 2004, but license
not withdrawn
8
Russian Retail Deposit Growth in 2004
Retail deposits approximately 70 billion at
year-end 2004
Source Central Bank of Russia
9
Russian Credit Growth Continues Through Market
Turbulence
At year-end 2004, total loans of Russian banks
totalled approx. 140b, of which retail loans
21b and loans to banks 10b
Personal loans doubled in 2004
Source Central Bank of Russia
10
Russian Banking Industry

• Effective measures and policies
• Tax reform has contributed to the economic boom
• Reform of securities markets underpins bank
  business and funding
• Bank deposit insurance step in right direction
• Reduction in reserve requirements boosts
  intermediation
• Remaining vulnerabilities/challenges
• Dominance of state banks Sberbank and VTB
  distorts market and holds back its development
• Limited economies of scale for private sector
  banks
• Continued lack of confidence (e.g. banking market
  panic in 2004)
• High single-party and related party
  concentrations create risks
• Arbitrary legal environment undermines creditor
  rights
• Opaque ownership perpetuates lack of trust

11
Russian Banking Sector Likely to Consolidate in
Medium-term

• Over 1,250 banks
• No single private sector bank has a market share
  of more than 6
• Deposit insurance scheme may lead to exit of
  marginal banks
•  
• Recent MA activity Nikoil/Avtobank/UralSib
  Rosbank/OVK VTB/Guta VTB/Promstroi
• Key question will FDI increase?

12
Restructuring of Turkish Banking
SectorComparison with Russia

• At beginning of 2000, Turkish financial sector
  had many similarities with Russian sector of
  2005
• Turkish state banks held important position,
  particularly in retail market
• State banks (particularly Ziraat and Halk) unfair
  competitors for deposits
• Banks relied on trading profits
• Several large FIGs with strong position in
  banking market (e.g. Sabançi, Cukurova, Dogus,
  Is, Koç)
• Engrained practice of intragroup lending in FIGs
• Banks profited from large equity holdings
• Low level of publicly-disclosed nonperforming
  loans
• Many marginal banks with weak franchises
• Ineffective banking supervision

13
Restructuring of Turkish Banking Sector
Comparison with Russia

• But a few key differences of Turkish banking
  sector Russia at the beginning of 2000
• Turkish state banks had weak financial profiles,
  in contrast to Sberbank and VTB
• Unlike Russian state banks, Turkish state banks
  distributed massive subsidies in agricultural,
  small business, real estate sectors
• Many Turkish private sector banks had deeper
  experience, longer track record, better
  franchises than todays Russian private sector
  banks
• Turkey had many fewer banks (79) than Russia

14
Massive Restructuring of Turkish Banking Sector
in Past Four Years

• New regulatory authority created, new banking law
  adopted
• Massive supervisory action Regulators took over
  weak banks representing 25 of sector (e.g.
  Pamukbank, Demirbank Iktisat, Esbank, Ticaret,
  Interbank, Imar Bank)
• Special audit for all private banks, with
  stricter rules on reporting problem loans,
  stricter enforcement of limits on intragroup
  loans and single party concentrations
• Number of banks reduced to 50 from 79
• Government guaranteed all retail deposits
  (partially withdrawn this year)
• Loan subsidies were shifted from state banks
  directly to government
• State banks recapitalized and downsized
• State RE bank Emlak closed, assets transferred to
  Ziraat and Halk
• FDI is starting to build (Fortis/Disbank)
• Total cost of restructuring est. 40-50 billion,
  or 30 of Turkish GDP

15
Lessons from Turkey

• Clean-up of banking sector costly if problems
  left unattended many years
• Strong, persistent regulatory actions required to
  break ingrained habits
• Level of problem loans during an expansion is
  poor indicator of potential extent of problems in
  recession
• True extent of intragroup lending difficult to
  assess
• Intragroup exposures increase in downturn

16
Systemwide Nonperforming Loans in Turkey Peaked
at 25 of Total Loans in 2001 Up from 3.5 in 1998
peak of 25 at yearend 2001
Source Central Bank of Turkey
17
Banking Sector Undevelopped in EEMEA Domestic
Credit to Private Sector to GDP
Source Standard Poors Data as of
year-end 2003
18
Domestic Credit to Private Sector to
GDPPotential for Growth in EEMEA and LA
19
Mortgage Lending in Emerging Markets Remains
Undevelopped
20
Polish Banking Industry

• Effective measures and policies
• Convergence of regulatory environment with EU
• Improvements in regulatory policy concerning
  problem loans (notably statistical provisions for
  personal loans)
• Act on Bankruptcy and Remedy Proceedings
  strengthened creditor rights
• Reduction of mandatory reserve requirements
• Remaining vulnerabilities /challenges
• Low average level of wealth
• High unemployment
• Inefficient public sector
• Rapid increase in personal debt
• Tough competitive environment has reduced margins

21
Diversified Foreign Ownership of Polish Banks
Foreign banks control 67 of banking assets as
of June 30, 2004
of total banking sector assets by banks by
country of origin
22
Turkish Banking Industry

• Remaining vulnerabilities/challenges
• Increase lending in a low inflation environment
  after years of easy profits from trading and
  investing in government bonds (in high inflation
  environment)
• Privatization of large state banks will be
  difficult
• Private sector banks weakened by recession of
  2001-2002
• Increasing foreign competition

23
Kazakhstan Banking Industry

• Effective measures and policies
• Relatively strong and independent regulator
• Successive reformist central bankers
• Group-level consolidated supervision enhances
  transparency
• Mandatory reporting under IFRS
• Enforceable creditor rights to collateral
• Remaining vulnerabilities/challenges
• Fast credit growth undermines asset quality and
  capitalization
• High single-party and sectoral concentrations
• Weak transparency with respect to bank ownership
• Risky expansion outside Kazakhstan
• High proportion of international borrowing
  (rollover risk)

24
Ukrainian Banking Industry

• Effective measures and policies
• New law on securing creditors' rights may improve
  the legal status of creditors
• Deposit insurance provides limited coverage of
  deposits at private banks
• The draft law on allowing foreign banks to open
  branches should promote competition
• Remaining vulnerabilities/challenges
• Pervasive practice of intragroup lending
• High single-party and sectoral concentrations
• Obscure bank ownership
• Weak/uncertain creditor's rights
• Poor and often tardy disclosure of financial
  performance