Update on Financial Stability How the E&E Countries Stack Up

1. Update on Financial Stability How the E&E Countries Stack Up

2. Outline • About PFS • Key role of financial sector in economic growth • Access to finance and investment for SMEs, agriculture, jobs • Financial stability: Regional news and overview • What if the European financial crisis worsens? • Biggest threat to stability, prosperity and democracy in E&E region • What can be done? 2

3. About USAID’s Regional Partners for Financial Stability Program • PFS helps countries more effectively address their financial sector challenges focusing on stability, access to finance and growth. • Program Activities and Approach • Regional training and study tours to mentor countries, bringing together key players in the region • Crisis related focus: deposit insurance, access to finance, crisis preparedness measures, problem loans • Research, surveys, publications • Partnerships, leveraging program funds • Strengthening domestic institutions 3

4. Illustrative PFS Activities Capital Markets Viability in SEE: Regional Integration and Harmonization Problem Loan Workouts: Series of Workshops for Bankers Crisis Preparedness Assessments: Strategic Plans for Central Banks, Fin. Ministries Targeted Bilateral Assistance: Tactical, Technological Deposit Insurance Assessments: Zeroing in and Correcting Weaknesses Examples: E-invoicing, export promotion, online collateral auction Total Cost: Under $70,000 4

5. How PFS addresses financial sector gaps and challenges Complements bilateral financial sector & ATF programs Albania, Bosnia, Ukraine, Macedonia Regional Initiatives • Often more efficient / effective than bilateral programs • Examples: • Capital markets integration in SEE • Financial crisis preparedness assessments • Deposit insurance evaluations • Banker training on problem loans Financial Sector Benchmarking, Research • Developed a comprehensive financial sector benchmarking system • Enhances Missions’ programming and planning Partnerships • Partnerships with over 150 organizations • Partners’: PFS cost sharing 3.5:1 on regional events 5

6. Key Role of Financial Sector in Economic Growth 6

7. Key Role of Financial Sector in Economic Growth • Providing Credit & Specialized Financial Services • Providing Capital Economic Growth and Incomes • Noncash Payment System • Savings and Investment Vehicles 7

8. Key Role of Financial Sector in Economic Growth • Facilitates the exchange of goods and services • Improves efficiency and volume of private sector activity • Supports higher growth and rising incomes • Reduces poverty 8

9. Fragile Banking Systems and Lack of Finance lead to: • Slower economic growth • Worse competitiveness • Higher unemployment • Youth issues • Political instability • Growth of populism and nationalism • Tensions with neighbors The gains made across the board in the late 1990s and early part of the last decade, particularly in access to finance, are threatened. 9

10. Financial Stability in SEE and Eurasia: Regional News and Overview 10

11. News from the Region – SEE • Emerging Europe: Decline in Bank Lending (4-2012) • Raiffeisen Group Boosts Liquidity on Fears of Greek Crisis Triggering Bank Runs in Balkan Nations (5-24-2012) • Serbia’s State-Owned Agrobanka Fails; Deposits are Transferred to a ‘Bridge Bank’ (5-28-2012) • Serbia: Two Banks Bailed out by the Government (4-23-2012) For more news visit: http://www.pfsprogram.com/leslie-sulentas-blog 11

12. News from the Region – SEE • IMF Considers New Support for Bosnia and Herzegovina (5-29-2012) • IMF Cautious on Montenegrin Economic and Banking Conditions (5-17-2012) • Slovenia’s Banking System Under Duress: NLB Bank Seeks Capital, Relies on ECB for Liquidity • Hungarian Bank Fails (6-7-2012) For more news visit: http://www.pfsprogram.com/leslie-sulentas-blog 12

13. News from the Region – Eurasia • National Bank of Ukraine Tightened Control Over Greek Banks’ Subsidiaries in Ukraine (5-30-2012) • Investors Again Reject Ukraine’s Hryvnia Bonds (5-20-2012) • IMF Completes Visit to Ukraine, Warns of Economic and Financial Challenges (5-30-2012) • Moldova Bank Fails (3-2012) • U.S. Calls Belarus’ Credex Bank a Money Laundering Hub (5-22-2012) For more news visit: http://www.pfsprogram.com/leslie-sulentas-blog 13

14. News from the Region – Eurasia • Azerbaijan: Largest Bank Bailed Out by Government (5-20-2012) • Azerbaijan: Banks Expand Lending But are Dogged byHighCredit Risk (5-14-2012) • Georgia: Tycoon Organizes Political Protests, Sells Bank in Russia (6-3-2012) • Russia’s Sberbank Building Its Own Bloc in Eastern Europe (4-13-2012) For more news visit: http://www.pfsprogram.com/leslie-sulentas-blog 14

15. E&E Economies Still Weak and Unstable – High Unemployment Highest Risk Beneficiary Countries: Kosovo, Macedonia, Bosnia, Serbia and Armenia 15

16. E&E Financial Sectors – Still Reeling from 2009 Shock Banks have alarming levels of bad loans across SEE and Eurasia 16

17. E&E Financial Sectors are Small and Underdeveloped Starved for credit: Azerbaijan, Armenia, Georgia, Kosovo 17

18. Biggest threat to stability, prosperity and democracy in Europe and Eurasia: What if the European Financial Crisis Worsens? 18

19. What if Greek Contagion Spreads to Southeast Europe? Deposit runs on Greek banks spread to Greek banks in Romania, Serbia, Albania, Kosovo Runs spreads to all foreign owned banks in SE Europe Lending halts, small banks close Deep recession, democratic backsliding • Albanian depositors panic • Many small banks are closed or forced to merge • Montenegro, Kosovo, Bosnia: lack of central bank liquidity (Euro users / pegged currency) • Instability and quiet, sustained bank runs spread to other foreign banks • IMF bailouts sought by Serbia, Montenegro • Deposit insurance funds run out: Bosnia • Currencies lose 50% of value across the region; banks and borrowers take hit from foreign currency loans • Unemployment passes 30% in Serbia, Macedonia • Non-performing bank loans 30% across SEE 19

20. What if Greece exits the Euro? • Major Italian, Austrian, French, and German banks are bailed out / partially nationalized • Bailouts are messy and unpredictable, feeding uncertainty and panic • Uncertainty about the Euro leads to full-blown depositor panics • Parents of Italian and Austrian banks in SEE are not able to provide liquidity to subsidiaries in some cases • Central banks are pushed to the limit in emergency lending to banks, strained to keep systemic banks open • Currencies lose 40-50% of value across the region • Financial instability spreads to Eurasia • Russia bails out the Ukrainian government Serbia, Bosnia, Montenegro, Macedonia, Ukraine: Unable to roll over debt Banks lose 40% of deposits Recession and Instability in Eurasia Ethnic tensions Increase: Macedonia, Bosnia 20

21. Eurozone Banks that Dominate E&E Financial System Are Under Pressure Foreign Bank Ownership in CEE: Highest of Any Emerging Region (2009-10) Source: National authorities, Raiffeisenbank, Financial Stability Board. 21

22. Eurozone Banks That Dominate E&E Financial Sector – More E&E Banks Would Collapse, Confidence Would Evaporate Many of the largest banks in Southeast Europe and, to a lesser extent, Eurasia are owned by foreign banks 22

23. Eurozone Banks Linkages Map – Online Demo Many of the largest banks in Southeast Europe and, to a lesser extent, Eurasia are owned by foreign banks. DEMO: http://www.pfsprogram.com/banks-map 23

24. Deleveraging of Banks and Access to Finance in Central & Southeast Europe Would Worsen Loan Growth Rate, Q1-2012 Negative loan growth in CEE due to bank deleveraging 24

25. Bilateral Trade With Troubled Eurozone Countries Would Decline Bilateral Trade as Percent of Selected Countries’ GDP Source: IMF Regional Economic Outlook, October 2011 25

26. Remittances from Eurozone Would Decline Remittances Vulnerability Index 26

27. Most Vulnerable Countries in E&E: • All of Southeast Europe • Especially Montenegro, Serbia, Bosnia, Albania • Eurasia also vulnerable • Georgia, Armenia, Moldova, Ukraine 27

28. Other Donors? • International Monetary Fund • World Bank “Time and resources are stretched too thin to make an impact in the financial sector in the E&E region.” • European Union “Focusing on stability in core member states.” 28

29. Financial Stability in E&E What Can be Done 29

30. To Maintain Financial Stability, E&E Countries Need: • Proactive, informed financial supervision • Stable macroeconomic policies • Sound banks and non-bank financial institutions • Local capital markets Good examples: Czech Republic, Poland 30

31. What USAID and PFS Can Do • Coordinate with other donors • Crisis preparedness assistance for financial authorities • Example: Kosovo • Rapid response: • Backing up deposit insurance agencies with skilled advisors • Example: Albania • SWAT teams to examine and support resolutions of failing banks • Provide training to resolve problem loans • Example: PFS training programs, Bosnia early 2000s • Multi-donor programs to keep some credit flowing 31

32. What USAID and PFS Can Do • Medium term / preventive • Support introduction of new products and credit underwriting techniques to reduce risk • Strengthen capital markets as a source of equity and hedging products • Example: PFS-EBRD market integration in SEE • Improve cross border supervision and cooperation 32

33. What USAID and PFS Can Do • Medium term / opening the markets • Work with financial institutions other donors to encourage access to finance • Example: Azerbaijan, Armenia, PFS • Assist in implementing post-crisis financial standards • Basle 3, SIFI supervision, bank resolutions • Financial education and consumer protection • Example: Ukraine • Guidance on strengthening deposit insurance funds and systems • Example: Bosnia, PFS 33

34. Annex Financial Sector Stability Indicators Source: PFS Financial Sector Benchmarking System 34

35. E&E Economies Highly Indebted – No Room for Fiscal Stimulus Highest Risk Beneficiary Countries: Montenegro, Serbia, Ukraine, Georgia, Armenia, Moldova, Bosnia 35

36. Most E&E Governments Have Large Budget Deficit Highest Risk Beneficiary Countries: Kosovo, Serbia, and Georgia (preliminary data) 36

37. Many E&E Economies Have Unbalanced Economies – Imports far Exceed Exports Highest Risk Beneficiary Countries: Kosovo, Montenegro, Albania, Armenia and Georgia (preliminary data) 37

38. 2012: Slowing E&E Economic Growth Forecasts Lowest 2012 Growth Forecasts: Serbia, Albania, Bosnia, Macedonia, Montenegro 38

39. E&E Financial Sectors are Small and Underdeveloped Capital markets do not support business growth 39

40. Access to Finance is Weak: Loans are Expensive Loans are expensive: Georgia, Armenia, Kosovo … across SEE & Eurasia 40

41. Access to Finance is Weak – Few Banks and Branches Lowest bank density: Ukraine, Belarus, Moldova, Serbia 41

42. E&E Financial Sectors – Lower Bank Profits Banks are still losing money in: Ukraine, Montenegro, (Romania, Slovenia, Hungary) 42

43. E&E Financial Sectors – High Risk Lending in Foreign Currency Predominates Lending in foreign currency endangers banks and borrowers across the region 43

44. E&E Financial Sectors – Many Banks are Not Liquid Most illiquid (lower bar is better): Belarus, Ukraine, Azerbaijan, Armenia, Georgia, Montenegro 44

45. How the Countries Stack Up – Financial Sectors are Weak 45

46. . Partners for Financial Stability (PFS) 1919 N. Lynn Street Arlington. VA 22209 Phone: +1 571 882 5000 Fax: +1 571 882 5100 www.pfsprogram.org David Cowles COTR USAID +1 202 567 4052 skeefe@usaid.gov dcowles@usaid.gov Leslie Sulenta Chief of Party Deloitte Consulting LLP +385 98 355 258 lsulenta@deloitte.com Lori Bittner Engagement Director Deloitte Consulting LLP +1 571 882 5330 lbittner@deloitte.com