1 How to avoid another serious financial crisis: Harnessing the benefits of financial integration Manfred Schepers, Vice President Finance, EBRD

2 CEE financial integration has supported growth….  Financial integration was a successful growth strategy.  Different for CEE vs other emerging markets where this link has been weak.  EU framework, accession, € area and commitment of foreign banks explain this.  In crisis parent banks supported subsidiaries and maintained exposures and capital coverage. Asset share of foreign-owned banks in total banking system assets

3 … though also instigated vulnerabilities.  Foreign banks’ role in the CEE region contributed to macro and financial vulnerabilities especially FX exposures.  Excessive credit growth was linked to global credit growth and competition for market share.  Stock of private sector FX debt currently holds back the recovery today. Domestic bank credit in foreign currency (% of GDP)

4 Local Currency and Capital Market Development  To reduce systemic risks associated with FX lending to unhedged borrowers Removes key vulnerability that impacts bank funding and valuation Enhances monetary policy effectiveness, and scope for counter- cyclical use of exchange rate instrument  Encourages domestic saving and investment Good for sustainable growth Good for external stability less reliance on foreign funding less external debt accumulation  Part of the quest for a better “growth model” reliant on more resilient funding and capital structures.

5 Opportunity for policy action  Post-crisis convergence across the CEE region Vulnerabilities resulted from FX lending as well as poor information standards and credit assessment Unsustainable external imbalances now widely recognised NOT a detour for eventual euro zone members  Post-crisis macro conditions make local currency a more rational proposition Narrowing interest rate differential vis-à-vis FX lending rates  Regulators forcefully addressing FX lending Creates a new demand for LCY lending which cannot be satisfied without domestic capital markets development  Insurance and pensions industry positioned for growth

6 Overall coordinated approach is needed  Governments need to focus on all factors that prevent development of local currency & capital markets Histories of inflation volatility and lack of macroeconomic credibility will take time to redress Need to address inadequate market CM infrastructure, and lengthen maturity structure and liquidity of sovereign debt markets  Commercial banks: Differentiate lending standards, taking account of FX risk Engage more actively across all aspects of LCY capital market  International Financial Institutions: To help through lending, investment and funding activities, making local markets more liquid, transparent and resilient