The global financial crisis and banking – Lessons from Emerging Europe Caijing Conference, December 13, 2008 Erik Berglof Chief Economist European Bank of Reconstruction and Development

The financial crisis now global Recession in all major industrial regions World trade and global capital flows falling Emerging markets facing ”sudden stop” Emerging Europe particularly threatened But even China severely affected ”Global Financial Architecture” discussion (once again) in full swing

Emerging Europe particularly affected Large currency movements, no collapse yet... Banking sector: deposit withdrawals + failures Real sector: industrial production dropping Fiscal capacity to respond limited IMF packages (Hungary, Ukraine, Serbia...)

Emerging European growth model Capital from rich to poor (19th century US) –Large current account deficits financed by FDI –Unparalleled financial integration Remarkably successful –Sustained high growth + institutions transformed Resilient in crisis, but also highly exposed –Current account deficits + foreign exchange debt

Emerging European financial system Eastern European banking system controlled (80 per cent) by international banking groups Remarkable financial deepening and institutional development -› financial access Parent banks support important reason why Eastern Europe so resilient in financial crisis Wholesale funding important complement – now faltering

Wholesale lending sharply down, but parent bank financing held up so far Total net bank lending: still high...in spite of declining wholesale lending Source: BIS Source: Dealogic

Failures of EU financial architecture made Eastern Europe vulnerable EU members (and candidates) forced to deregulate their capital accounts Households and firms led to believe countries would join the Euro zone => forex exposure Regulation and supervision through home- host country coordination failed Lack of centralized financial regulation and supervision at the EU level

Crisis response in Western Europe further amplifies weaknesses of EU architecture Passively: drawing deposits and capital flows away from weaker countries and distorting competition Actively: limiting international banking groups’ ability to support subsidiaries across borders In a financially integrated system, national rescues can have adverse external effects Reinforced the crisis in Eastern Europe, and worsen as the capitalization of banking groups deteriorates

Lessons from Emerging Europe Remarkable financial development and improved financial access driven strong economic growth But model vulnerable to the closure of financial markets and wavering parent bank support Incomplete integration and failures in regional regulation and supervision reinforced vulnerability Weaknesses in regional financial architecture now also worsen impact of crisis