By Jürgen Rigterink, First Vice President and Head of Client Services Group, European Bank for Reconstruction and Development (EBRD)
A year after Russia’s invasion of Ukraine, the world saw the emergence of a potential new crisis this March—three US lenders and the globally systemic Credit Suisse bank failed, bringing turmoil to the banking world prompted by fears of contagion with the potential for a repeat of the chaotic banking collapses of 2007-08.
In the world’s most sophisticated markets, however, something like calm has returned since early spring. For now, at least, these failures seem to have been contained, with new regulatory mechanisms quickly deployed in major markets, earlier calls for deregulation of banking now falling silent on both sides of the Atlantic and even discussions at the Washington spring meetings about opportunities for further strengthening of the rules.
But where does this latest upheaval leave the countries of Central and Eastern Europe (CEE), Central Asia and the Southern and Eastern Mediterranean (SEMED)—where the European Bank for Reconstruction and Development (EBRD) works and where economies are already under pressure from the knock-on effects of the war on Ukraine?
Although the current turmoil followed the closings of Silicon Valley Bank (SVB), Signature Bank and Silvergate Bank (Silvergate Capital Corporation)—due in the first two cases to runs on deposits in March prompted by fears of collapses and, in Silvergate’s case, to losses connected with cryptocurrency customers—it is worth remembering that these events were preceded by a large bank closing closer to home in the early summer of 2022. Sberbank Europe, the European arm of Russia’s biggest savings bank, saw its headquarters in Austria and subsidiaries in Bosnia, Croatia, Serbia and Slovenia close after sanctions on Russia spurred significant deposit outflows—showing the potential links between the war and possible disruptions in banking.
In the Central and Eastern European region—the heartland of the EBRD, which was set up in 1991 to foster the private sector and market economy in once-communist countries formerly under Soviet influence—countries have been fighting more than just the worldwide inflation that had been climbing even before gas prices rocketed up before the start of the war. Russia’s weaponising of energy supplies and raw materials has also brought severe disruptions to supply chains, with damage caused to firms across the entire region’s real economy, as well as refugee flows within Ukraine and into neighbouring countries and beyond.
In the February update to its Regional Economic Prospects1 forecasts, the EBRD expected output in the Bank’s regions,2 which stretch across three continents, to grow by just 2.1 percent in 2023, down from the 3.0 percent predicted in its last report in September.3
In Ukraine, which saw a 30-percent drop in its gross domestic product (GDP) in 2022 as a consequence of the invasion, growth is expected to stagnate at around 70 percent of 2021 levels. And growth forecasts have been adjusted downward in more than half of the 36 economies in which the EBRD works, with very few upward revisions. It is only in 2024 that growth in the Bank’s regions is expected to pick up to 3.3 percent.
At the same time, average inflation in the EBRD regions dropped to 16.5 percent in December after peaking at 17.5 percent in October (a rate last recorded at the end of the transition recession in 1998).
The EBRD is working to mitigate the consequences, with record lending in 2022 to support the real economy in Ukraine and neighbouring states. It has committed to invest €3 billion in Ukraine in 2022-23; in 2022, it deployed €1.7 billion, with a further €200 million mobilised from partner financial institutions and more than a billion of risk generously shared by shareholders and donors.
Nevertheless, the latest banking upheaval, on top of the regional impacts of the invasion, is inevitably bringing greater ferment to the banking industry in already stretched EBRD countries of operations.
The pressure points banks there face today, like other banks in other regions, are market and credit risks. Looking at these one by one: With firms working in conditions of great uncertainty, credit risks are higher than before the war as companies operating in the real economy may become likelier to struggle to repay loans or fold. Market risks are growing, too, as assets reprice. As the European Central Bank (ECB) recently noted, a potential intensification of geopolitical tensions in the future may further increase repricing risks in financial markets and also cyberthreats.
Then comes liquidity risk: Can we expect contagion between what happened in March in the United States and its risks in the EBRD’s countries of operations? The good news for EBRD regions, as in other parts of the world, is that there has been no contagion. So far, banks have not seen significant deposit outflows in countries where the EBRD invests.
However, turbulence in the banking sector is, in turn, causing turbulence in the market for bail-in-able bonds, which are already getting more expensive. And this begs the question about the extent to which this further expense faced by banks might, in turn, feed into the real economy and add to the existing strains on it.
For banks in EBRD member countries that are also in the European Union (EU) and have access to advanced markets, the short-term future for bail-in-able bonds—Additional Tier 1 (AT1) paper, the second most junior element in a bank’s capital structure after the equity that constitutes the shareholders’ returns—is uncertain.
Still, in most EBRD countries of operations, banks rely largely on more traditional funding—deposits, both retail and corporate—with wholesale funding playing a lesser role, so this is less a cause of anxiety. For them, if any credit risks do materialise, it could take several quarters for them to show.
A potentially more worrying trend is the acceleration of changes that have been slowly progressing since the global financial crisis of 2008, when the Western banks that had moved into EBRD regions in force a generation ago began to reduce their presences.
This evolving process can be seen across the EBRD regions. Many French banks that once had strong presences in North Africa, for instance, have now left. Western banks that could obtain cheaper funding than their local counterparts have pulled out of Greece, Cyprus and the Western Balkans.
Instead, new, more local cross-border players have emerged, populating the changing investment landscape. But they do not have the same deep pockets and access to capital markets, making their funding more expensive. As the world becomes more politically fragmented, cross-border banking reflects that change by becoming more difficult, more local and more costly.
Inside the European Union, the answer is the banking union, which should ensure a common banking market for 300 million people but remains incomplete. But beyond the European Union—and most of the EBRD’s countries of operations are outside it—the tendency toward fragmentation of the banking industry risks losing the benefits of cross-border banking: greater efficiency, sharpened know-how, deeper pockets, better governance and improved risk management.
Today, the war on Ukraine is bringing added pressures that are speeding up that fragmentation, with some cross-border banks that had exposure in Russia pre-war struggling to shed their assets there (which they can only do with the Russian state’s permission) and facing questions from other markets in the region that might limit the scope of their operations.
EBRD countries of operations benefit from the anchor of European rules and the availability of cross-border finance, whether they have been formally accepted as EU accession candidate countries—such as Ukraine and Moldova—or simply hope to be on a path toward EU convergence. Such countries are supposed to accelerate their growth rates to make the investments needed to achieve the required momentum in the convergence process, and those efforts rely on finance. National savings are usually not enough to finance the necessary level of investment, so they need capital coming in from abroad. Relying purely on national savings means, quite simply, that financing becomes less abundant.
Although the EBRD supports the idea of integration in the banking system, one could, however, also rationally argue that there is some upside to a more local approach. This can be thought of as a trade-off between the slower growth associated with less exposure to cross-border banking and the greater stability it may bring—because, in times of trouble, foreign capital inflows can more easily be suddenly reversed, while local financing is less prone to volatility.
And even if the acceleration of this change, which already had been slowly altering the banking landscape for some years, is not altogether positive, the key piece of knowledge to keep in mind when considering the future of the banking sector is that banks in 2023—shored up by the protective measures put in place after 2008—are less likely than ever before to go under.
Since the global financial crisis (GFC), much emphasis has been placed on fixing banks, which now benefit from stronger capital bases, improved supervision and more predictability when it comes to resolving financial institutions. True, the framework has not been tested by a full-blown crisis, and we are not out of the woods yet in terms of the surprises the current bout of turmoil might bring. But the fact that this framework is in place, along with sharp minds ready to offer creative solutions if a workaround should be needed, offers considerable comfort as we move forward.
References
1 European Bank for Reconstruction and Development (EBRD): “Regional Economic Prospects: Not out of the woods yet,” February 2023.
2 European Bank for Reconstruction and Development (EBRD): “Where We Are.”
3 European Bank for Reconstruction and Development (EBRD): “Reduced gas supplies and inflation to slow growth further in EBRD regions,” Marcus Warren, September 28, 2022.