Ralph de Haas Office of the Chief Economist EBRD Regional financial integration and the impact of the financial crisis Black Sea Conference on Regional Integration and Inclusive Growth Athens, 23/

Overview Financial integration Impact crisis on growth Crisis response

Emerging European growth model based on financial integration ’Capital from rich to poor’ –Unparalleled process of financial integration –Allowed large current account deficits –Financed through FDI and foreign bank lending Has been remarkably successful –Sustained high growth rates –Unprecedented institutional transformation –Strong public balance sheets

Financial integration resulted in large current account deficits, more than in other emerging markets

Substantial build up of private debt

Maturing syndicated loans in 2009

Externally financed growth model now under attack... Depth of financial integration increased vulnerability of the region –Large current account deficits, excessive credit growth, high private sector debt Though structure of foreign funding - FDI and intra-bank lending - has (as yet) added resiliance Region is now hit with full force –Capital inflows slowing dramatically Syndicated lending and bond markets dried up Will foreign parent banks continue to subsidiaries? –Deposit withdrawals and bank failures –Very substantial currency devaluations –Industrial production dropping precipitously, sharp slow-down in export markets

… but longer-term benefits of financial integration likely to stay Built-up stock of physical and human capital FDI-related transfer of industrial know-how Financial infrastructure and know-how in place (e.g. local banks as arrangers syndications) Advantages foreign-bank ownership (cf. Kazakhstan…)  Improved risk management  Increased ownership transparency  New lending technologies such as credit scoring  Committed parent banks…

Overview Financial integration Impact crisis on growth Crisis response

The crisis hit hard in Q4 2008, and output fell sharply across the region Industrial production growth CDS spreads, latest vs. August 08

Growth forecast 2009 reduced by 1-6 points for all countries in the region 2008 GDP growth, % 2009 GDP growth, %

From the financial crisis to a crisis of transition? Direct effects Financial development likely to regress, with most immediate impact on SME sector FDI may fall sharply → less transfer of skills Private sector participation in large infrastructure more difficult (but more needed) Effects via policies and reform reversals Large-scale privatisations could be reversed Trade liberalisation challenged (particularly in countries that are not members or candidates of EU)

A cautionary tale: transition reversals during/after the Russian 1998 crisis

Overview Financial integration Impact crisis on growth Crisis response

Fighting the crisis: Short run Monetary and fiscal policies: no one-size-fits-all. Right policies depend on: –strength of public balance sheet –credibility of monetary and fiscal institutions –currency composition of debt –state of domestic demand The overriding challenge (almost everywhere): to protect the core banking system. May require cross- border coordination of recapitalization of parents and subsidiaries. Another key challenge: maintaining SME financing

Fighting the crisis: international challenges Need to safeguard the stability of parent banks and banking systems in transition region Crisis-management so far at national level (except ECB liquidity support & IMF packages) Problems: 1.Negative spillovers by drawing deposits and capital flows from countries unable to provide sufficient government support 2.‘Protectionist’ approach prevents ‘leaking’ of support packages: impedes efforts of multinational banks to fund or recapitalise subsidiaries across borders 3.Absence of co-ordination between host and home authorities, parent banks, and subsidiaries: inaction and under-provision of financial support

Joint IFI Initiative (1) Objective: joint work to address funding needs in a co-ordinated manner Need for a flexible co-ordination framework that brings together key stakeholders: –Home-country authorities –Host-country authorities –IFIs (EBRD, EIB, IFC/World Bank) –Parent banks and subsidiaries

Joint IFI Initiative (2): burden-sharing Parent banks: contributions expected in terms of maintaining capital and funding commitments IFIs: complementary contributions in line with capacity to deliver Host governments: liquidity support, capital injections, deposit insurance (if and when needed) Note: possible need for currency swaps in tandem with LC liquidity support Home governments: follow up on implementation of national support packages

Joint IFI Initiative (3): three platforms 1.IFI discussions with regional banking groups to discuss business plans and funding needs 2.IFI coordination with home and host country authorities (Vienna meeting) 3.Host-country co-ordination of stakeholders

Thank you