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.

0

20

40

60

80

100

1998  2000  2002  2004  2006  2008 

Per centCEB SEEEEC RussiaTurkey CA

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.

0

10

20

30

40

50

60

70

80

90

100

Lettla

nd

Estla

nd

Alban

ien

Serbie

n

Kroat

ien

Litauen

Tajik

ista

n

Bulgar

ien

Ungarn

Ukrai

ne*

Kazak

hstan

Mold

avie

n

Polen

Russla

nd

Tschec

hien

Mitte 2004 Mitte 2008

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