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Austrian Banks To Limit Exposure to Central, Eastern Europe

DIETER NAGL/AFP/Getty Images Hungarian Prime Minister Viktor Orban (L) and Austrian Chancellor Werner Faymann at the World Economic Forum in Vienna

Summary
For the past two decades, Austrian banks have focused on expanding into Central and Eastern Europe, a strategy that has largely shielded Austria from the effects of the crisis in Western Europe. However, this exposure to countries that have experienced financial instability since the beginning of the European crisis such as Romania, Hungary and Ukraine has had some drawbacks, endangering banks' subsidiaries that operate in those countries and their Austrian headquarters and, most recently, with Standard & Poor's Jan. 13 decision to downgrade Austria's credit rating. Despite this, Austria still sees Central and Eastern Europe as a profitable market, so it will continue to be a central financial player in the region while simultaneously working to limit its exposure to the riskiest countries.

Analysis
The Austrian banking sector's heavy influence in Central and Eastern Europe has had both benefits and drawbacks during Europe's ongoing financial and political crisis. While it has remained largely shielded from the bulk of the crisis facing Western Europe, it has begun to see an increasing amount of nonperforming foreign-denominated loans from Central and Eastern European countries. Austrian banks' exposure to financially unstable countries such as Hungary and Ukraine was part of the reason for Standard & Poor's decision to downgrade Austria's credit rating from AAA to AA+ on Jan. 13. S&P believes Vienna could be forced to issue new bailouts for its banks, a move that would increase Austria's public debt, which is currently around 72 percent of gross domestic product (GDP). In 2009, Vienna had to launch a banking package of 100 billion euros ($128 billion), which included capital infusions, state guarantees to ensure access to liquidity and insurance coverage. Despite these recent setbacks, Austria still considers Central and Eastern Europe both a profitable market and key to its efforts to establish a greater geopolitical foothold in its near abroad. It will thus remain a central financial player in the region in the near future while attempting to limit its presence in the riskiest countries.

Austria's Banking Influence in Eastern Europe

Austria benefited from the 1991 fall of the Soviet Union in two ways. First, the country went from being a frontier state at the edge of the Iron Curtain to being the geographic center of the European Union's eastward expansion. At the same time, formerly communist countries in Central and Eastern Europe were beginning to open their markets to the world, creating the need for banking sectors that these countries had neither the expertise nor capital to create or maintain by themselves. Vienna saw this as an opportunity both for financial gain and to gain back some of the influence it possessed at the height of the Austro-Hungarian Empire. It used these historical ties in the region to greatly expand its financial presence in Central and Eastern Europe by participating in the privatization of formerly state-owned

banks, opening its own banks in former Soviet satellites and providing direct cross-border loans. As a result of this process, Austrian banks today hold a market share of almost 20 percent in Central and Eastern European countries. Austrian banks' total international exposure in the first quarter of 2011 was 380 billion euros, or 134 percent of its GDP. In terms of GDP, Austria is more exposed than France (121 percent of GDP) but less than the United Kingdom (173 percent) or Switzerland (323 percent). Two-thirds of Austria's exposure is concentrated in Central and Eastern Europe, with its largest claims in the Czech Republic, Romania, Hungary, Croatia and Slovakia. Austria is not the only player in the region, either; Russia is gradually increasing its presence and trying to take advantage of the financial crisis in Europe by purchasing banks in its former Soviet area of influence.

Benefits and Risks

Austria's eastward-looking strategy has meant that its banks have had limited exposure to the financial crisis in Western Europe. Austrian banks' main Western European subsidiaries are located in Germany, Italy, the United Kingdom and the Netherlands, with only marginal exposure to troubled countries such as Ireland, Spain, Greece and Portugal. Austrian banks are still feeling the crisis, however, both in the real economy and in the financial sector of Central and Eastern European countries. Credit conditions are becoming more restrictive for companies and households in the region, and corporations are seeing their access to funds dwindle as the liquidity of the markets dries up. In particular, Austrian banks are seeing trouble with foreign-denominated loans. Large parts of the loans in Eastern European countries are denominated in foreign currency (mostly euros and Swiss francs), and difficulties in payment arise when local currencies devalue against them. By mid-2011 more than two-thirds of Austrian banks' loans to households in countries such as Hungary, Romania, Ukraine and Croatia were foreign-denominated. The situation was particularly complex in Ukraine, where the hryvnia faced a major devaluation in mid-2008, and to a lesser extent in Hungary and Romania, which saw respective devaluations of the forint and leu. The result of this process was a dramatic increase in delinquencies, as borrowers became progressively unable to repay their loans -- the average nonperforming loan ratio for Austrian banks operating in Central and Eastern Europe is 14.1 percent, almost twice as high as the ratio for banks operating in Austria. In response, Austrian banks changed their business strategy, first by tightening credit conditions and lending approval standards, increasing interest rates and scaling back operations in the region. In this regard, Austrian banks sought to consolidate their presence in "low risk" European Union countries such as the Czech Republic (where local banking regulations prevent risky lending practices) and Slovakia (which, as a member of the eurozone, boasts a more stable financial system courtesy), and limit their exposure to non-EU countries such as Ukraine. Second and more important, Austrian banks slowed lending in foreign currency. While the stock of these loans declined by 5.8 percent in the first half of 2011, Swiss franc loans still account for around one-fifth of all foreign currency loans granted by Austria's main banks to households and non-financial corporations. Despite this reduction, the volumes of such loans -- both in Austria and in Central and Eastern Europe -- still constitute a considerable risk for Austrian banks. Recent policy measures in some Eastern and Central European countries, such as the Hungarian government's intervention in foreign currency loan contracts or the introduction of banking taxes in Hungary and Slovakia, are also hurting the profitability of Austrian banks in the region. Therefore, although the promised benefits are high, the future of Austrian banks is tied to the economic -- and political -- fate of Central and Eastern Europe.

Continued, Cautious Investment

Central and Eastern European countries are still far less financially developed than those of Western Europe. Moreover, the region has Europe's best long-term growth prospects: Even amid the current crisis, Central and Eastern Europe is expected to have an average growth differential of 2 percent more than Western Europe by 2016, according to Eurostat predictions. Austrian banks thus continue to see the region as a profitable market and will remain a central financial player there, though they will seek to limit their presence in the most problematic countries -- especially those outside the European Union -- while trying to redesign their presence in those safer for doing business. Consequently, Austria's political and economic influence on Central and Eastern Europe is likely to be mixed and to vary by country, concentrating in the more stable, profitable countries while decreasing in the more risky countries, so long as its banks seek to protect themselves from the crisis.