Towards a new international financial architecture

Peter SanfeyLead Economist, EBRD

19 November 2009

The transition region is in deep crisis

2009 average output decline: 6.3 per cent

Double-digit declines expected in 5 countries (Baltic countries; Ukraine, Armenia).

Crisis is not over: rising non-performing loans and unemployment

Slow recovery expected for 2010

Romania among the countries hardest hit (minus 8% in 2009, plus 1% in 2010)

Output declines were deep, sudden, and heterogeneous…

-15

-10

-5

0

5

10 Q3 2008 Q4 2008

Q1 2009 Q2 2009

Quarter on quarter GDP growth, per cent (seasonally adjusted)

…but no full-fledged “twin crises”. Why?

1. Net capital outflows were less sharp than in previous crises (e.g. Asia) and other regions.

2. Financial systems were comparatively sound (high foreign bank presence, small non-bank financial sectors)

3. Forceful, coordinated and comprehensive crisis response

In most transition countries, net capital outflows were comparatively modest

Percentage changes in external assets of BIS-reporting banks

-3.4

-11.1

-4.4

-7.8

-11.9-15

-10

-5

0

5

10

15

Emerging Europe(excl. UKR, RUS)

Russia &Ukraine

CA andCaucasus

Latin America Emerging Asia

Per centAvg 2007Q4/2008Q1 Avg 2008Q4/2009Q1

Crisis response has been effective

Domestic policies: Massive in western Europe and mature in central and eastern Europe

Forceful & coordinated international support

– IMF resources tripled from $250 to $750 bn

– EBRD investments up more than 50% this year

– EU BOP support quadrupled from €12.5 to €50 bn

Parent banks maintained exposures

New coordination platform – Vienna Initiative

External balance of payments support (Percent of GDP)

International support packages are much larger than in the Asian crisis

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

Q3 1997 Q4 1997 Q1 1998 Q2 1998 Q3 1998 Q4 2008 Q1 2009 Q2 2009 Q3 2009

Korea Thailand Philippines Indonesia Hungary Latvia Romania Ukraine

The Vienna Initiative has helped maintain foreign bank funding

Coordination among banks to maintain exposures Joint IFI (EBRD/EIB/WB) support to bank groups Home country authorities allow parent bank

support of subsidiaries Host country authorities to provide liquidity equally

to foreign and domestic owned banks

The CEB and SEE growth model has three components1. Political, legal-regulatory integration with EU2. Trade integration (particularly with the EU)3. Financial integration, led by EU banks

External assets and liabilities, 1994-2008 Foreign bank asset share, 1998-2008

0

50

100

150

200

250

1994 1996 1998 2000 2002 2004 2006

CEB SEE EEC

Russia Turkey CA

Per cent of GDP

0

20

40

60

80

100

1998  2000  2002  2004  2006  2008 

Per cent CEB SEE EEC

Russia Turkey CA

In transition countries, capital inflows are correlated with higher growth

y = 0.1681x + 5.0106

R2 = 0.1201

-2

0

2

4

6

8

10

12

14

-20 -10 0 10

CA/GDP, % (av. 1994-2008)

Gro

wth

GD

P p

er

ca

p,

PP

P

(av

.19

94

-20

08

)

-2

0

2

4

6

8

10

12

14

y = -0.3442x + 5.2813

R2 = 0.2697

02468

101214161820

-15 -10 -5 0 5 10

CA/GDP, % (av. 1994-2008)

Gro

wth

GD

P p

er

ca

p,

PP

P

(av

.19

94

-20

08

)

02468101214161820

… in contrast with the experience in other emerging market regions.

Non-transition sample Transition sample

Financial integration is good for long-term growth in transition economies Financial integration associated with growth

– 1 per cent of GDP in inflows raised annual growth by 0.15-0.4 percentage points per year

– 10 percentage point higher foreign bank share raised growth 0.2-0.4 percentage points per year

Financially dependent firms grew faster in financially integrated transition economies

– 1.5 percentage points per year faster in high capital inflow countries than in low inflow countries

Foreign banks are associated with better output performance in the crisis

ARM

LAT

UKR

SVK

LITEST

ROM

HRVBULTAJ

AZE

BLR

KAZ

TURRUS SLV

MOL

KGZHUN

SRB

MNE

POL

BiH

ALB

GEOFYR

CZE

-25

-20

-15

-10

-5

0

5

0 20 40 60 80 100 120

Share of foreign bank assets in % of total assets, 2007

Ou

tpu

t g

row

th o

ver

2008

Q4

- 20

09 Q

1, q

-o-q

, sa

, %

-25

-20

-15

-10

-5

0

5

But capital inflows fed credit booms and external (over-)indebtedness…

Cross-border debt inflows and domestic credit growth, 2005-08

HUN

SLVBiH

HRVCZEPOL

FYRBUL

RUSTAJ

SER

ALB

LIT

MOL

EST ROM

KAZAZE

UKR

LAT

R2 = 0.2988

0

10

20

30

40

50

60

70

80

90

-20 30 80 130 180 230

Average credit growth between mid-2005 and mid-2007, %

Med

ian

gro

wth

of

BIS

len

din

g b

etw

een

mid

-20

05 a

nd

mid

-20

07, %

0

10

20

30

40

50

60

70

80

90

… and contributed to FX lending in domestic financial systems

Foreign bank asset share and share of FX lending in total lending

UKR

LAT

EST

LIT

MOL

RUS

TUR

ARM

SLV

AZE

KAZ

HRV

BUL

SER

HUN

ALB

POL

FYR

0

10

20

30

40

50

60

70

80

90

100

0 20 40 60 80 100 120Asset share of foreign-owned banks, %

Sh

are

of

fore

ign

cu

rre

ncy

len

din

g in

to

tal

do

me

stic

len

din

g, %

0

10

20

30

40

50

60

70

80

90

100

Financial integration: policy implications

Continue to integrate

– Only region in the world where financial integration mostly worked the way it was supposed to

Manage risks and unintended consequences

– Take away the froth through tougher lending standards, and use of macro-prudential instruments

– Reduce FX liabilities via better macro institutions, local currency market development, regulation.