Do Foreign Banks Raise the Risk of Foreign Currency Lending in CEE?

1
Do Foreign Banks Raise the Risk of Foreign
Currency Lending in CEE?
23rd Workshop of the Austrian Working Group on
Banking and Finance December 12-13, 2008, Vienna

• P. Haiss, A. Paulhart, W. Rainer
• Europe Institute, Vienna University of Economics
  and Business http//www.wu-wien.ac.at/europainstit
  ut/forschung/nexus

... The opinions expressed are the authors
personal views
2

• MONETARY INTEGRATION, GROWTH AND COUNTRY RISK -
  Nexus

Team Manager Peter Haiss Current and previous
team members Johannes Bolzano, David Blum, Timea
Edelenyi, Markus Eller, Klaus Federmair, Bettina
Hagmayr, Sirma Hristoforova, Dagmar Inzinger,
Magdalena Kamecka, Elisabeth Kichler, Herwig
Kirchner, Bernhard Mahlberg, H.C. Mantler,
Marie-Therese Marek, Stefan Marin, Sindhu
Olimalayil, Nikolai Pantel, Ina Paripovic,
Andreas Paulhart, Andreas Pichler, Wolfgang
Rainer, Petra Roessl, Bernhard Sammer, Milena
Staeva, Katharina Steiner, Kjell Suemegi, Ulrike
Moser, Mina von Varendorff, Nastja Vogl, Goran
Vukšic, Jennifer Weidinger, Andrea Ziegler NEXUS
WebPage http//www.wu-wien.ac.at/europainstitut/
forschung/nexus
3
Agenda

• Trends in Fx-lending FSFDI
• Motivation for the Paper
• Method and Data
• Selected Results
• References

FX foreign currency FSFDI financial sector
foreign direct investment
4
Development of FSFDI
Asset share of foreign banks (over 50 foreign
ownership) Source Own calculations, data from
RZB Group 2004, 2005, 2006, 2007, 2008
5
Development of Foreign Currency Lending
Foreign currency loans as of total
loans Source Own calculations, data from RZB
Group 2004, 2005, 2006, 2007, 2008
6
Motivation I - Case of Hungary

• High indebtedness
• Reliance on external funding
• Fx-borrowing in Hungary
• 2008 almost 90 of loans to private sector in
  foreign currency
• Over 50 of total credits to households
  denominated in fx
• In the wake of financial crisis
• Forint came under pressure ? surging repayment
  obligations
• Downgrading of Hungarys creditworthiness
• IMF, EU World Bank 21 billion rescue package
• Banks imposed restrictions on fx-lending or
  suspended it right away

Exposure to tightened financial markets
7
Motivation II

• High share of FSFDI in Central South-Eastern
  Europe
• Growing level of foreign currency lending in
  many CEE countries

• European Commission (2004) Cross-ownership in
  the banking sector might contribute to high
  levels of fx-lending in the new member states
• Farnoux/ Lanteri/ Schmidt (2004, 21) Poland
  foreign banks tend to issue fx-loans more often
  than domestic institutions

Credit to the private sector in of GDP
FX
National currency
Source Rosenberg Tirpak (2008)
Haiss, P., Paulhart, A., Rainer, W.
7
8
Motivation III

• Sorsa, Backer, Duenwald, Maechler Tiffin
  (2007) The drive of (foreign) banks to
  complement limited earnings oppor-tunities at
  home with high profits from emerging Europe may
  have led to risk under-pricing ... this
  under-pricing may be compounded by limited data
  on creditworthiness and weak institutions
• Luca and Petrova (2007) and Basso, Calvo-Gonzalez
  and Jurgilas (2007) Foreign banks want
  currency-matched portfolios ? may prefer
  fx-lending
• OeNB (2007, 43) and IMF (Tieman, 2007 IMF,
  2008) Austrian banks may foster fx-lending in
  CEE because of their experience with fx-loan
  issues at home

9
Conceptual Framework
10
Method Data I

• Method
• Linear regression model
• Level of fx-credit as dependent variable, diverse
  explanatory variables
• ANOVA ? check influence of qualitative features
• Data
• Data on 16 transition countries for the period
  1999-2006
• RZB Group 2004, 2005, 2006, 2007
• Erste 2008
• EBRD Banking Data

11
Method Data II

• General regression model
• Introduction 20 threshold on asset share of
  foreign banks
• Waschiczek (2002) herding behavior contributes
  topopularity of fx-loans in Austria
• Tzanninis (2005) herding and spreading through
  word of mouth

12
Overview Results
Significant negative (95)
not significant
Significant positive (95)
13
Results I Asset Share of Foreign Banks

• Relationship not significant
• With 20 threshold increased significance
• Negative relationship for PEG countries

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Results II Fx-Deposits

• Positive relationship between fx-deposits and
  fx-lending
• FLOAT countries strongest relationship?
  confirming the theory that banks seek to limit
  theirexposure to currency fluctuations

15
Results III Fx-Deposits

• Adjusted R² 0.466
• Beta 0.691
• Significance 0.000

16
Results IV Export Orientation

• Contrary to theory significant negative
  relationship
• FLOAT and PEG significant negative relationship
• ERM II insignificant
• However, no distinction between household and
  corporate fx-lending!

17
Results V Market Concentration

• Significant positive relationship confirming the
  theory that fx-lending is a function of the size
  of banks
• FLOAT ERM II significant positive relationship
• PEG significant negative relationship

18
Results VI Real Exchange Rate Change

• General model significant negative relationship
• FLOAT ERM II significant negative relationship
• PEG insignificant

19
Next Steps

• Distinguishing household from corporate
  fx-borrowing
• Apply multivariate approach (panel regressions)
  instead of bivariate regressions
• Add new variablesworkers remittances, GDP,
  dummy for bank crisis
• Introduction of dynamics (time lags)
• Investigate impact of mode of market entry
  possible herd behavior

20
References I
Arteta, Carlos Óscar (2002), Exchange Rate
Regimes and Financial Dollarization Does
Flexibility Reduce Bank Currency Mismatches?,
CIDER Working Paper No. C02-123. Backé, Peter,
Ritzberger-Grünwald, Doris, and Stix, Helmut
(2007), The Euro on the Road East, Monetary
Policy and the Economy Q1/07, 114-127,
OeNB. Basso, Henrique, Calvo-Gonzalez, Oscar and
Jugilas, Marius (2007), Financial Dollarization
The Role of Banks and Interest Rates, ECB Working
Paper No. 748, May 2007, http//www.ecb.eu/pub/pdf
/scpwps/ecbwp748.pdf (6.4.2008). Boissay,
Frederic, Calvo-Gonzalez, Oscar and Kozluk,
Tomasz (2006), Is Lending in Central and Eastern
Europe developing too fast? Preliminary draft,
paper presented on the Conference on European
Economic Integration, 14-15th November 2005,
Vienna, http//www.eu-financial-system.org/fileadm
in/content/Dokumente_Events/second_conference/Bois
say_Calvo-Gonzales_Kozluk.pdf (9.4.2008). Bokor,
László and Pellényi, Gábor (2005), Foreign
Currency Denominated Borrowing in Central Europe
Trends, Factors and Consequences, ICEG EC Opinion
Nr. 5, February 205, International Center for
Econmic Growth European Center Breuss, Fritz,
Fink, Gerhard, and Haiss, Peter (2004), How well
prepared are the New Member States for the
European Monetary Union? Journal of Policy
Modeling 26, 769-791 Catao, L, and Terrones, M.
(2000), Determinants of Dollarization The
Banking Side, IMF Working Papers WP/00/146,
http//www.imf.org/external/pubs/ft/wp/2000/wp0014
6.pdf (8.4.2008). Delgado, F. L., Kanda, D. S.,
Casselle, G. M. and R.A. Morales (2002), Domestic
Lending In Foreign Currency in Building Strong
Banks through Surveillance and Resolution, Enoch,
C., Marston, D. and M. Taylor (eds.),
International Monetary Fund, Washington D.C.,
40-61.
21
References II
EBRD (2005), Transition Report 2005, European
Bank for Reconstruction and Development,
London. ECB (2005b), Lending Booms in the New EU
Member States Will Euro Adoption matter? ECB
Working Paper No. 543, http//www.ecb.int/pub/pdf/
scpwps/ecbwp543.pdf (9.4.2008). ECB (2006a),
Macroeconomic and Financial Stability Challenges
for Acceding and Candidate Countries, ECB
Occasional Paper series, No. 48,
http//www.ecb.int/pub/pdf/scpops/ecbocp48.pdf
(9.4.2008). ECB (2006b), EU Banking Sector
Stability, November 2006, www.ecb.int/pub/pdf/othe
r/eubankingsectorstability2006en.pdf
(9.4.2008). EIU Economist Intelligence Unit
(2008) EIU Country Data, https//eiu.bvdep.com/ver
sion-2008226/cgi/template.dll?product101
(1.3.2008). Eller, Markus, Haiss, Peter, and
Steiner, Katharina (2006), Foreign direct
investment in the financial sector and economic
growth in Central and Eastern Europe The crucial
role of the efficiency channel, Emerging Markets
Review 7, 300-319. Égert, Balázs (2007), Central
Bank Interventions, Communication and Interest
Rate Policy in Emerging European Economies, OeNB
Working Paper Nr. 134, http//www.oenb.at/de/img/w
p134_tcm14-51029.pdf (6.4.2008). Erste Bank
(2008), SEE Banks Boom or bust? CEE Equity
Research Sector Report, February 19,
2008. European Commission (2004), Financial
Market Integration and the Use of the Euro in the
New Member States, Quarterly Note on the
Euro-Denominated Bond Markets, No. 75, September
2004, http//ec.europa.eu/economy_finance/publicat
ions/bond_markets/2004/bondq0304_en.pdf
(7.12.2007). Farnoux, Marc, Lanteri, Marc, and
Schmidt, Jerome (2004), Foreign direct investment
in the polish financial sector, Case study
prepared for the CGFS Working Group on Financial
Sector FDI, http//www.bis.org/publ/cgfs22bdf.pdf
(9.4.2008).
22
References III
Fink, Gerhard, Haiss, Peter, and von Varendorff,
Mina (2007), Serbias Banking Sector Reform
Implications for Economic Growth and Financial
Development, Southeastern European and Black Sea
Studies 7(4), 609-636. Got, Xavier and Ross,
Alise (2006), The Foreign Currency Gamble
Rising Risks For Banks In Central And Southeast
Europe, Standard Poors Ratingsdirect, Aug. 23,
2006. Guidotti, P. and C. Rodriguez (1992),
Dollarization in Latin America Greshams Law in
Reverse?, International Monetary Fund Staff
Papers, 39(3), 518-544. Herzberg, Valerie and
Watson, Max (2007), Growth, risks and governance
The role of the financial sector in southeastern
Europe, European Economy Occasional Paper No. 29,
April 2007, European Commission
Directorate-General for Economic and Financial
Affairs, Brussels. IMF (2006) De Facto
Classification of Exchange Rate Regimes and
Monetary Policy Framework. http//www.imf.org/exte
rnal/np/mfd/er/2006/eng/0706.htm (9.4.2008). IMF
(2008), Austria-2008 Article IV Consultation,
Preliminary Conclusions of the Mission, March 17,
2008, http//www.imf.org/external/np/ms/2008031708
.htm (18.3.2008). Ize, A. and E. Parrado (2002)
Dollarization, Monetary Policy and the
Pass-Through, IMF Working Paper, No.188. Karmin,
Craig and Perry, Jiellen (2007), Homeowners
Abroad Take Currency Gamble in Loans, The Wall
Street Journal, May 29, 2007 Levy Yeyati, Eduardo
(2006), Financial dollarization evaluating the
consequences, Economic Policy, Jan. 2006,
61-118. Luca, Alina and Petrova, Iva (2007), What
drives credit dollarization in transition
economies?, Journal of Banking and Finance, doi
10.1016/j.jbankfin.2007.06.003.
23
References IV
Tieman, Alexander (2007), Cross-Border Banking
Issues for the Austrian Banks and Their
Supervisors, in IMF (ed.) Austria Selected
Issues, IMF Country Report No. 07/143, April
2007, 30-43. Martens, Jul (2003), Statistische
Datenanalyse mit SPSS für Windows, 2. Auflage,
München und Wien, Oldenbourg. OeNB (2007),
Austrian Financial Intermediaries Benefit from
the Benign Economic Climate, Financial Stability
Report 13, 37-65, http//www.oenb.at/en/img/fsr_13
_tcm16-57616.pdf (9.4.2008). Rosenberg, Christoph
and Tirpak, Marcel (2008) Determinants of
Foreign Currency Borrowing in the New Member
States of the EU, IMF Working Paper No. 08/173,
http//www.imf.org RZB Group (2004, 2005, 2006,
2007), CEE Banking Sector Report, Raiffeisen
Research, October of the respective years Sorsa,
P., Bakker, B., Duenwald, C., Maechler, A. and
Tiffin, A. (2007) Vulnerabilities in Emerging
Southeastern Europe How Much Cause for Concern?
IMF Working Paper No. 07/236 Tzanninis, Dimitri
(2005), What Explains the Surge of Foreign
Currency Loans to Austrian Households? In
Epstein, Natan and Tzanninis, Dimitri (eds).
Austria Selected Issues, IMF Country Report No.
05/249 3-37, http//www.imf.org/external/pubs/ft/
scr/2005/cr05249.pdf (6.4.2008). Uzun, Arzu
(2005), Financial Dollarization, Monetary Policy
Stance and Institutional Structure The
Experience of Latin America and Turkey, Thesis
submitted to the Graduate School of Social
Sciences of Middle East Technical University,
http//etd.lib.metu.edu.tr/upload/12606739/index.p
df (5.4.2008). Waschiczek, Walter (2002), Foreign
Currency Loans in Austria - Efficiency and Risk
Considerations, in OeNB, Financial Stability
Report 4, Wien, 83-99, http//www.oenb.at/en/img/f
sr_04_tcm16-8061.pdf (9.4.2008). Wieser, Thomas
(2008) An Austrian perspective, presented a the
EBRD 2008 Conference on the liquidity crisis in
CEE, Dec. 4 2008,  http//www.ebrd.com/country/se
ctor/fi/conference/present.htm World Bank (2007),
World Bank EU 82 Regular Economic Report, Part
II Special Topic January 2007,
http//siteresources.worldbank.org/INTECA/Resource
s/EU82_SpecialTopic.pdf (30.3.2008).
24
Contact

• Peter Haiss
• Vienna University of Economics and Business
  Administration
• peter.haiss_at_wu-wien.ac.at
• Andreas Paulhart
• Vienna University of Economics and Business
  Administration
• andreas.paulhart_at_cemsmail.org
• Wolfgang Rainer
• Vienna University of Economics and Business
  Administration
• wolfgang-rainer_at_gmx.at

For more of our research, see http//www.wu-wien
.ac.at/europainstitut/forschung/nexus
25
Back-up
26
FX-loan-levels in CEE - much higher than in
other emerging markets

• Source Rosenberg Tirpak (2008)

27
Regulatory measures - to slow down FX borrowing

• Source Rosenberg Tirpak (2008)

28
Results Asset Share of Austrian Banks

• No significant relationship in the general model
• FLOAT countries significant positive
  relationship
• PEG and ERM II significant negative relationship

29
Results Interest Rate Differential

• No significant relationship in the general model
• PEG significant positive relationship
• ERM II significant negative relationship

30
Results Inflation Differential

• General model not significant
• PEG significant positive relationship
• ERM II significant negative relationship

31
Results Exchange Rate Regime

• Error bar showing the means of fx-loans for
  FLOAT, PEG and ERM II countries
• FLOAT 39.9
• PEG 35.0
• ERM II 44.9

32
Results Market Concentration II

• Adjusted R² 0.171
• Beta 0.422
• Significance 0.000

33
Financial Globalization- impact is subject to
thresholds

• Kose, M., Prasad, E., Rogoff, K. Wei, SJ
  (2007) Financial Globalization Beyond the Blame
  Game, Finance Development 44(1),
  http//www.imf.org/external/pubs/ft/fandd/2007/03/
  kose.htm

34
High Inflow of FSFDI to CEE-10
of GDP
CEE-10 BG, HR, CZ, EE, HU, LV, LT, PL, Sl,
SK Source Eller, Haiss and Steiner 2007
35
Foreign banks dominate CEE-NMS

• Source RZB (2008) CEE Banking Sector Report,
  Sept. 2008

36
Austrian banks exposure to CEE

• Austrian banks are significant
  players in CESEE countries
• Market share about 22 (without RF)
• Austrian exposure in CESEE
• 1/3 of overall Austrian exposure
• 2/3 of GDP (BIZ-data without BA, HGAA gt about
  100 of GDP if these banks are included!)
• SESEE segment is highly profitable for major
  Austrian banks

Source Wieser, Thomas (2008) An Austrian
perspective, presented a the EBRD 2008
Conference on the liquidity crisis in CEE, Dec. 4
2008,  http//www.ebrd.com/country/sector/fi/conf
erence/present.htm
37
Some foreign banks might not be able to fund
growth as much as they did in the past

• Source Revoltella, Debora (2008) Overview of
  banking sector funding under the current
  liquidity crisis, paper presented a the EBRD 2008
  Conference on the liquidity crisis in CEE, Dec. 4
  2008, http//www.ebrd.com/country/sector/fi/confer
  ence/present.htm

38
Foreign Currency loans as CEE-specific risk
Unlike Western European peers, CEE banks are not
involved in sub-prime related investments and
much smaller relative to GDP
? no asset write-offs, no
emergency capital increases

• However
• HU, BG, RO, HR (less PL) have high FX-loans
• Massive transfer of liquidity by foreign banks to
  support CEE units
• cut and run is no option for foreign banks
• their business model is committed to the region

Source Wieser, Thomas (2008) An Austrian
perspective, presented a the EBRD 2008
Conference on the liquidity crisis in CEE, Dec. 4
2008,  http//www.ebrd.com/country/sector/fi/conf
erence/present.htm
39
X-border exposures by foreign banks (SE, AT, IT,
DE, FR) create new channels of contagion
Source Rosenberg, Christoph (2008) Foreign
Currency Borrowing More Risky for Eastern Europe,
IMF Survey Oct. 28, 2008, http//www.imf.org/exter
nal/pubs/ft/survey/so/2008/car102808a.htm
40
References

• Eller, Markus / Haiss, Peter / Steiner, Katharina
  (2007) Auslandsdirektinvestitionen im
  Finanzsektor Osteuropas Treiber für
  Wirtschaftswachstum, Effizienz und
  Unternehmensentwicklung? In Moser, Reinhard
  (ed.) Ausländische Direktinvestitionen, Gabler,
  Wiesbaden 213-236
• Kose, M., Prasad, E., Rogoff, K. Wei, SJ
  (2007) Financial Globalization Beyond the Blame
  Game, Finance Development 44(1),
  http//www.imf.org/external/pubs/ft/fandd/2007/03/
  kose.htm
• Revoltella, Debora (2008) Overview of banking
  sector funding under the current liquidity
  crisis, paper presented a the EBRD 2008
  Conference on the liquidity crisis in CEE, Dec. 4
  2008, http//www.ebrd.com/country/sector/fi/confer
  ence/present.htm
• Rosenberg, Christoph (2008) Foreign Currency
  Borrowing More Risky for Eastern Europe, IMF
  Survey Oct. 28, 2008, http//www.imf.org/external/
  pubs/ft/survey/so/2008/car102808a.htm
• RZB (2008) CEE Banking Sector Report, Sept. 2008
• Wieser, Thomas (2008) An Austrian perspective,
  presented a the EBRD 2008 Conference on the
  liquidity crisis in CEE, Dec. 4 2008,
   http//www.ebrd.com/country/sector/fi/conference/
  present.htm