Corporate Governance

of Banks in Eurasia

Dr Sibel Beadle,Principal Banker, EBRD

Role of Company Secretary in Bank

Governance

London, United Kingdom

30 April 2008The views expressed in this paper are those of the author and do not necessarily represent the opinions of the OECD

or its Member countries or the European Bank for Reconstruction and Development

Impact on EBRD Countries of

Operation

Sub prime Exposure

– What Happened?

– Exposure of Financial Sector in EBRD Countries of Operation

Liquidity Squeeze

– Vulnerability – Credit growth and Dependence on External Funding in EBRD Countries of Operation

– Alternative Funding Sources?

How did the sub prime crisis start?

Initially – US housing prices, started to fall

and sub prime mortgage borrowers started to

default

First half of 2007 – Acknowledgement from

the FED that the broad based defaults could

lead to $50 Billion of write downs

August 2007 – Crisis became visible when

ECB had to inject the first Euro 95 Billion into

money markets

Current Level of Write Downs

SocGen $4bn

UniCredit $0.8bn

RZB $0.04bn

Citi

Merrill

UBS

Morgan Stanley

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000

$40,000

Mortgage Related Write-Downs

(91 financial companies, 177bn)

Source: Moody's and BBC

How large are the losses?

Still uncertain

First week of February – Tokyo meeting –

German Finance Minister revealed that the

G7 thought losses could reach $400 bn

New write-downs since February

How could this happen?

October 2007 Fitch announces

– 26% of downgrades from all rated 2006 sub prime RMBS

– Many from investment grade to speculative grade

January 2008 Moody’s announces

– Downgrades on 53.3% of the 2006 vintage tranches (representing 93.4% of the deals backed by first- and second-lien sub prime mortgages)

– Downgrades on 38.2% of rated tranches of the 2007 vintage

February 2008 S&P announces

– Downgraded $183 billion out of $3.24 trillion in original issuances (an additional $588.31bn put on credit watch

– Securities that S&P downgraded from investment grade to speculative-grade did account for about 63% of the downgrades by original issuance volume

Downgrades are still continuing…

What does this mean concretely—

Structured Finance Rating changes S&P

AAA AA+ AA AA- A+ A A-

BBB

+ BBB BBB- BB+ BB BB- B+ B B-

CCC

+ CCC CCC- CC D

AAA 83.6 0.7 1.3 0.4 0.7 0.6 0.6 0.5 1.0 0.9 0.5 1.5 0.3 0.25 1.08 0.47 0.96 1.1 1.86 1.3 0.39

AA+ 84.6 2.1 0.7 0.9 1.5 0.3 0.4 1.9 0.1 0.4 2.5 0.04 2.63 0.09 0.09 1.23 0.04 0.18 0.04

AA 0.1 0.2 74.3 1.4 1.1 2.0 1.0 0.7 2.0 0.6 0.7 2.9 0.2 0.28 2.81 0.35 0.64 4.56 1.23 2.55 0.4

AA- 0.1 0.5 62.4 1.8 1.7 0.9 1.0 2.0 0.8 0.5 3.0 0.3 0.22 7.55 0.22 0.34 13.32 0.84 1.9 0.62

A+ 56.8 1.4 1.5 1.6 2.3 0.9 0.9 3.4 0.4 0.33 3.32 0.44 0.16 23.58 0.65 1.69 0.54

A 0.1 0.0 0.1 61.3 1.7 1.4 2.6 1.1 1.1 3.4 0.5 0.84 2.25 0.49 0.35 14.01 1.44 6.07 1.13

A- 0.1 47.9 2.9 3.3 1.3 0.7 4.0 1.1 0.6 3.79 1.02 0.23 23.14 0.88 7.45 1.67

BBB+ 43.2 2.4 2.3 1.8 4.9 1.2 0.97 4.56 0.92 0.15 25.72 0.36 8.66 2.87

BBB 0.0 0.1 0.0 52.8 2.4 2.6 4.4 0.8 0.97 4.63 0.73 0.32 14.46 1.67 11.71 2.37

BBB- 0.1 0.0 38.4 2.3 4.8 1.4 0.85 6.26 1.38 0.08 23.54 0.28 16.3 4.27

BB+ 24.9 2.5 1.4 1.06 5.42 1.36 23.91 0.48 26.52 12.49

BB 0.1 0.1 56.2 2.2 0.82 12.73 0.92 0.05 12.84 0.27 9.09 4.79

BB- 64.4 4.7 9.4 2.01 10.07 4.03 5.37

B+ 1.8 85.45 9.09 3.64

B 0.09 69.84 5.29 23.1 0.09 0.88 0.71

B- 83.3 2.08 12.5 2.08

Downgrades

Impact on EBRD Countries of

Operation

Sub prime Exposure

– What Happened?

– Exposure of Financial Sector in EBRD Countries of Operation

Liquidity Squeeze

– Vulnerability – Credit growth and Dependence on External Funding in EBRD Countries of Operation

– Alternative Funding Sources?

How is the liquidity squeeze

connected to the sub prime

High uncertainty in financial markets

– Increased risk aversion

– Initial uncertainty on exposure caused spill over to all

markets

– Spreads widened, funding has become expensive and

sometimes was not available any loner

Funding problems in EBRD countries where rapid

credit growth was heavily reliant on external funding

Differences of Western World vs.

EBRD Countries of Operation

Western Markets:

Asset Problems

Rest of the World:

Liquidity ProblemsWorldwide incl. EBRD countries

- Could lead to asset problems

over time

- Uncertainty in markets led to

difficulty in raising external funds

Risk Categories among EBRD

Countries of Operation

High risk factors:

– High credit growth mainly driven by wholesale funding—For example, banks in Kazakhstan (the worst hit country by the liquidity problem) and the banking system in the Baltic Countries

– Banking systems that do not have a sufficiently diversified funding base; in particular, those with a weak deposit base

– Countries that face other macro economic or financial problems (high deficits, large external imbalances, pressure on currency, housing bubble) are likely to be worse affected by the credit squeeze

Risk mitigating factors:

– Strong foreign exchange reserves—determined intervention by a central bank backed by strong foreign exchange reserves

– Strong presence of foreign banks—particularly, if the parent is willing and able to provide liquidity support

– Strong deposit base of the banking system

However, even in banking systems with high deposit levels deposits can move to large systemic banks or state banks—flight to quality/government guarantee

Or in countries with low level of deposits individual banks can have a strong customer base

Financial Intermediation and Credit

GrowthFinancial Intermediation – Bank Credit to Private Sector/GDP)

(2004 vs 2007)

2004

2004

2004

2004

2004 2

004

2004 2

004

20

04

2004

2004

2004 2

004

2004

2004

2004

2004

2004

2004

2004

2004

2004

2007

2007

2007

2007

2007

2007 2007

2007

2007

2007

2007

2007

2007

2007

20072007

2007

2007

2007

2007

2007

2007

0

20

40

60

80

100

120

140

160

180

200

Cre

dit

/GD

P (

in P

erc

en

t)

EU

CIS

Baltics

SEE

ETC

2004

By Region

Change in Bank Credit to Private Sector/GDP

(2004 - 2007)

0

10

20

30

40

50

60

Esto

nia

Latv

iaLi

thu

ania

Kaz

akh

stan

Ukr

ain

eSl

ove

nia

Bu

lgar

ia

Cro

atia

Ge

org

iaH

un

gary

Ru

ssia

Ro

man

ia

Cze

chM

old

ova

Mac

edo

nia

Po

lan

dSl

ova

kia

Aze

rbai

jan

Serb

iaA

rme

nia UK

Fran

ce US

BPS

CE

CIS

Baltics

SEE

ETC

Deposit Base by Region

Source: CEE Banking Sector Report; EBRD; Fitch Ratings. * or latest available

Baltics

CIS

CEE

SEE

ETC

Figure 2: Customer Deposits/Total Bank Assets (2007*)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

Alb

ania

Slo

ven

ia

Bu

lgar

ia

Mo

ldo

va

Mo

nte

ne

gro

Bo

snia

Mac

ed

on

ia

Cze

ch

Slo

vaki

a

Arm

en

ia

Cro

atia

Aze

rbai

jan

Taji

kist

an

Ukr

ain

e

Ge

org

ia

Ro

man

ia

Po

lan

d

Kyr

gyz

Lith

uan

ia

Esto

nia

Be

laru

s

Latv

ia

Hu

nga

ry

Serb

ia

Kaz

akh

stan

Ru

ssia

Foreign Ownership

Source: CEE Banking Sector Report; EBRD; Fitch Ratings

ETC

SEE

CEE

CIS

Baltics

Figure 3: Foreign Ownership (% of total assets)

0

20

40

60

80

100

Es

ton

ia

Czec

h

Slo

va

kia

Bo

sn

ia

Cro

ati

a

Ro

man

ia

Lit

hu

an

ia

Hu

ng

ary

Se

rbia

Bu

lgari

a

Ge

org

ia

Po

lan

d

Latv

ia

Arm

en

ia

Slo

ve

nia

Ukra

ine

Aze

rba

ija

n

Ru

ss

ia

Ka

za

kh

sta

n

Bela

rus

%

Increase in the Cost of Risk at the

Country Level

CDS, 5 Year Default, Foreign Currency Bps

0

50

100

150

200

250

300

350

Kazakhstan Ukraine Russia Poland Hungary Estonia

31 December 2006 31 December 2007 Peak Now, 29. April 08

x5.6

x4.5

x2.1

x1.7

x3.6

x2.2 x7.7

x2.9

x9.6

x5.3

x28.4

x17.0

Liquidity and Funding By Region --

Baltics

The largest vulnerability of the Baltics region is stemming from extraordinarily rapid credit growth prior to the credit squeeze

Depositor base of the Baltic countries is not as strong as in some other regions; only 50% of funding is provided by customer deposits.

Foreign ownership – high, but strategics have higher funding costs

Liquidity and Funding By Region -

Baltics The largest vulnerability of the Baltics region is stemming from extraordinarily

rapid credit growth prior to the credit squeeze

Depositor base of the Baltic countries is not as strong as in some other regions; only 50% of funding is provided by customer deposits.

Foreign ownership – high, but strategics also have higher funding costs

Overall, the majority of banks in the Baltics are controlled by Scandinavian banks—slow down in the Baltics would impact profitability of Scandinavian banks and increase of funding costs of the parent would influence profitability and growth of banking in the Baltics

– For example, currently 15 % of Swedbank’s total lending and more than 30% of its operating profit is stemming from Swedbank’s Baltic banking operations

– Swedbank’s wholly owned subsidiary Hansabank is the market leader in Estonia, Latvia and a major player in Lithuania.

– S&P to revise the outlook of Swedbank to negative from stable on December 18, 2007.

Fitch ratings changed the outlook for Latvia and Estonia to negative on January 31, 2008; prior to that Fitch had downgraded Latvia to BBB+ on August 17, 2007)

Liquidity and Funding By Region –

CEE/SEE Credit growth in EBRD countries that are a part of the EU have been moderate compared to

other regions—The high growth countries among the EU countries were Bulgaria and Slovenia.

Bulgaria as well as Slovenia has a very strong customer deposit base and customer deposits make up about 80 percent of total assets of the banking sector--except for Hungary for all countries in this group more than 50 % of funding comes via customer deposits

Foreign ownership is very high, often above 80

However, large variations in concentration of ownership. In some of the countries the presence of foreign banks is concentrated among a few large strategics. For example:

– Czech Republic, the three largest banks CS (Erste), CSOB (KBC), KB (Soc Gen), make up more than 50 percent of the banking sector assets

– Poland, other than UniCredit which owns Bank Pekao and Bank BPH (2nd and 3rd largest banks in the country), none of the foreign strategics have a larger than 7 percent market share

Therefore, the impact of the liquidity crisis in this region is rather complex and can often be influenced by:

– changes in the funding conditions of a few strategics

– or can be largely biased by strategic decisions—For example, in some of these countries, due to the competition among large international banks to retain or increase market share the increased funding costs have not been fully passed through to the end consumer, yet.

CEE/SEE

Source: EBRD, Monitoring Reports, Raiffeisen, CEE Banking Sector Report

Figure 5: Foreign Ownership--Parent Bank

(Percent of Total Banking Sector Assets)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100% Other Foreign

Bayern LB

Intesa

KBC

SocGen

RZB

UniCredit

Erste

Wholesale funding of the Strategics

Selected European Banks: Dependence on

wholesale financing as of March 2008

Rati

o o

f o

uts

tan

din

g d

eb

t secu

riti

es t

o t

ota

l

loan

s (

%)

Source: GFSR, April 2008, IMF, page 26

Original Sources: Bloomberg L.P.;Thomson Worldscope;and IMF

0

10

20

30

40

50

60

70

0 5 10 15

Average debt maturity in years

Swedbank

DnB

SEB

Handel

Dexia

Nati

Unic

Sanp

Raiff Dansk

Norde

BBV

Sant

Rabo

Erst

Liquidity and Funding - Kazakhstan

Kazakhstan has experienced one of the most exuberant credit growths prior to the liquidity squeeze—The sudden drying up of world wide credit in August led to a large disruption in the banking sector.

– Rapid growth in private credit was mainly funded by external credit.

– Further, the deposit base of banks was one of the weakest among the countries of operation

– Relative limited foreign ownership at the time, banks also had little alternative funding source

Nonetheless, the relatively strong FX reserves and the ability and willingness of the Kazakh authorities to intervene were very important in fending off the immediate distress situation that was created in August and September 2007.

Even in the case of Kazakhstan, which was the most affected country in the region, the rating for the country itself and for individual banks did not change materially, reflecting the very strong fundamentals the region has compared to historic episodes of financial turmoil

Liquidity and Funding - Russia

Among the CIS countries, Russia—while not immune—compared to other CIS less vulnerable to the liquidity squeeze (moderate to high credit growth)

Extraordinary FX reserves

– key role in providing great credibility to the Russian central bank during the height of problems

– was also recently acknowledged by S&P and led to a change in the outlook for the Russian sovereign to positive from neutral on March 11 2008

However, weaknesses in the funding base of banks exist

– Funding to small and medium sized banks is severely restrained

– Lowest ratio of customer deposits to total banking sector assets (among EBRD countries)

– Low foreign ownership of banks

– Government support for the smaller banks’ is likely to be less than the large players in the market.

Liquidity squeeze may accelerate consolidation in the banking sector, including potentially greater concentration towards the state sector

One distinct difference in Russia, compared to many other EBRD countries of operation, is that driven mainly by the strong oil prices and the solid economic growth, the corporate sector is still strong

– corporate as well as retail customers continue to ask for loans

– Banks (unlike in some other markets) can pass on the additional cost of funding to the customer, since the end customer is able as well as willing to pay for the higher cost.

FX Reserves of Russia

Foreign Exchange Reserve of Russia are Exceptionally

Strong driven by High Oil Prices

0.00E+00

5.00E+10

1.00E+11

1.50E+11

2.00E+11

2.50E+11

3.00E+11

3.50E+11

4.00E+11

4.50E+11

5.00E+11

RUSSIA

Liquidity and Funding By Region --

ETC

High credit growth but driven by low base

Resilience compared to historic experience

Going forward:

– Liquidity squeeze is likely to slowdown growth in

banking sector

– Slowdown in world GDP growth likely to impact

region

Thank you!