Are banking standards in the region improving? And which are the best banks? EM finds out in a new ranking that focuses on the banks' intrinsic strengths. We also ask three experts for their views on the industry. Tomorrow, we focus more specifically on the best banks in non-EU countries
EM: How strong is banking in CEE?
Mart Toevere: In terms of size, product penetration and so on, CEE banking is still at least a decade or two (depending on the region) behind western Europe. However, in terms of technology, most CEE banks are well ahead of their western counterparts.
This is also very true for the Baltic banking market – still quite low penetration levels, but probably one of the most modern and innovative banking markets in Europe. HansaBank group has over 1.4 million internet bank customers, and around 90% of our transactions are performed outside the branches through electronic channels (cards, ATMs, mobile banking, internet banking).
Kurt Geiger: There's a big difference between the countries and the regions. Those countries that have joined the EU or are applying to join have different financial sectors to those in Russia, Ukraine or central Asia.
It's also to do with the fact that the economies in the EU countries are quite strong. Most of the banks in these countries benefit from foreign investment and technology transfer. OTP in Hungary and Pekao in Poland are two success stories. But foreign investment is not the only factor in these banks. These banks also have very strong local management, such as HansaBank. In other countries it's a little bit different. The central Asian countries suffer from having very small economies and very few local companies. In Ukraine and Russia, the banks lack capital to finance growth. So the main issues are: the size of the market, the size of the banks and access to capital.
James Watson: Since the last banking crisis in 1998, banks in CEE have benefited from generally fast-growing domestic economies, positive feelings surrounding EU accession, investments carried out by foreign investors (particularly in the areas of risk management and in the introduction of new products) and generally stronger supervisory authorities, who have been armed with tighter prudential regulations.
However, competition has been increasing and, along with lower domestic interest rates, this has led to a fall in margins. Costs have also been slow to come down. Nonetheless, performance has been improving, partly thanks to the impact 'convergence' of interest rates has had on their large bond portfolios.
Exceptions have been Poland, which has been going through a tough macroeconomic environment since the beginning of the century, and Hungary, where the economy has been heating up, with volatile interest rates and foreign currency rates.
Overall, banks have been doing better, as reflected by the gradual upgrades in their individual ratings. In terms of long-term ratings, however, a widening gap is appearing between the foreign-owned banks and those which are mostly domestic-owned, since there are often still weaknesses in the corporate governance of the smaller banks, with quite high levels of related party lending and high concentrations in their loan books.
In Russia, Kazakhstan and the Ukraine, banks have also benefited from high rates of economic growth in recent years, which have enabled them to expand their businesses without, to date, suffering any large-scale deterioration in asset quality.
As in CEE, margins have come down as competition has increased, although they still remain relatively healthy.
Profitability is constrained, though, by the lack of scale of many banks, due to low sector assets-to-GDP ratios and, particularly in Russia, lack of sector consolidation. Kazakh authorities have led the way in improving banking regulation and supervision in the region.
EM: How strong is retail and corporate lending?
Mart Toevere: Since many of these markets started to grow in the 1990s (and in most cases household savings and income levels were minimal back then), growth primarily came from the corporate segment at first. Over the past five to seven years, however, we have seen a gradual shift towards the retail market, and at least in the Baltic countries, retail and corporate lending carry equal weight already. For our group, the retail lending growth rate was 51% (+e700 million) and corporate lending growth rate 28% (+e850 million) in 2004.
Kurt Geiger: Obviously there's always been a trend, when you look at the development of the financial services industry, that banks start off with corporate lending, especially in large and medium-sized companies.
As economies evolve, you see a significant pick-up in retail lending – in making loans to consumers. The issue is also one of the wealth of the population. As a bank, if you approach the retail market in the right way, there is potentially huge demand. You have to evolve step by step. I think this is one of the biggest challenges banks face: as they grow quickly and the demand for credit continues to rise, they have to digest growth in the market.
James Watson: Corporate lending has traditionally been stronger than retail lending in CEE, although retail customers are beginning to borrow, particularly in the form of mortgages and on credit cards. The growth seen in the loan portfolios of most banks across CEE is largely the result of growth in retail loans. The penetration of loans to GDP, however, remains substantially lower than in the rest of EU. In the CIS, as in CEE, corporate lending has traditionally been the mainstay of most banks' business. However, as top corporate names have increasingly gained direct access to international sources of finance, banks have gradually been forced to refocus their lending activities towards medium-sized companies, small businesses and retail customers.
In Russia, Ukraine and Kazakhstan, retail lending has initially focused on point-of-sale consumer lending and car loans. Mortgage lending has been held back by legislative and refinancing problems, but is now developing fast in Kazakhstan; credit cards are also becoming a more popular retail lending vehicle across the region.
EM: Foreign institutions own most banks in the region. Does this mean that they are competitive against their western peers?
Mart Toevere: I do not think that foreign ownership a priori adds to competitiveness. It is possible, there are some good examples, but there are also examples where things have not gone so well. It usually provides the local bank with cheaper funding and stronger capital backing, but very often also slows down the decision-making process, which gives an advantage to other local players. So it's a tricky job finding the right balance to achieve the best synergies from such ownership.
Kurt Geiger: They have to make investments in products and IT, but they can buy a lot of these products. One of the issues in banking is that there are very few trade secrets. There are no patents for products.
In the medium term, banks in the new member states have very good growth prospects because the economies are growing faster than in "old Europe" and with a lower cost base. It is those western banks that have a strong presence in central and eastern Europe that investors like the most.
They are highly profitable; they trade at very high multiples, therefore they should be able to raise money for growth; and these countries have a relatively young workforce that is willing to learn. So there are many opportunities for banks in central and eastern Europe to outshine their western rivals.
James Watson: The foreign-owned banks in CEE tend to be focused on their domestic market, and do not compete generally across borders (unless it is further east into CIS, or in the case of the Balkans, further south), leaving their parent company to deal with cross-border or treasury/trading business. They compete with each other in their own individual country.
The banking sectors of Russia, Ukraine and Kazakhstan have so far remained predominantly domestically owned, reflecting the still high risks of doing business in these markets. However, there has been increasing interest from foreign banks in acquiring stakes in leading institutions in the Ukraine and Kazakhstan, and some major deals might be concluded this year.
In Russia, foreign interest has so far focused mainly on medium-sized retail banks; many large international players are instead, however, looking to develop their own retail franchises.
EM: One of the problems in CEE, especially Russia, is that there are too many banks. Is more consolidation probable?
Mart Toevere: Yes and no. A large number of such banks are actually not true banks, but more like corporate treasuries for a group of companies. So, as long as that group of companies wants to keep that bank operational it will be on the market. Among universal and other banks that serve a larger number of customers, there probably will be further consolidation. It seems that in smaller countries it is optimal that the three largest banks have around 80% market share. In larger countries the markets are obviously more fragmented.
Kurt Geiger: Russia is a big country so it needs a lot of banks, so I don't think the issue is one of the numbers of banks. The important questions are: are the banks transparent; do they have good shareholders; do they offer good products and services; and is their customer base big enough to help grow critical mass?
There has been consolidation in a number of countries – for example, the Czech Republic in the early 1990s had 40 local banks. None of them has survived. Consolidation is also taking place in Russia. The central bank is trying to raise the minimum capital requirement for the banks. It is very important to have sufficient players in the banking industry to give the private sector a choice of products. There has to be competition. Also, there is always room for niche players.
James Watson: Apart from Russia, the number of banks in each country is lower than, say, Italy, France or Germany. Furthermore, the margins these banks are able to command are still substantially high, and therefore it is unlikely that there will be consolidation among them, unless mergers drive such consolidation between their parents.
In terms of exiting a market, strategic investors seem to have taken a very long-term view, and as a result even those with weaker franchises seem determined to stay. In most of the CEE countries, in any case, there is extremely high concentration among the largest three or four banks, with the rest competing in niche or very local markets.
In Russia, the vast majority of institutions with banking licences are small entities serving as either treasuries for their shareholders' other assets or funds investing in local securities. Among larger institutions, which are usually focused primarily on third-party banking business, there is considerable scope for consolidation, and some significant transactions have already taken place.
Going forward, this process is likely to accelerate as sector-wide margins come under more pressure, creating the need for scale, and merger and acquisition procedures are simplified. In Kazakhstan, the banking sector is far more consolidated than in Russia, with the top three banks having a joint market share of over 60%, while the Ukraine, where the top 10 banks account for just over 50% of assets, offers greater scope for M&A activity.
Joint Winner HansaBank
The success of HansaBank is a microcosm of the dramatic changes that have taken place in some of the former Soviet Union republics. The bank was founded in Estonia in 1991 by a group of men who had little knowledge of commercial banking but had an instinct for entrepreneurship and a vision of what a bank should do.
Today, HansaBank is the biggest financial institution in the Baltic countries, with a strong presence in Estonia, Latvia and Lithuania. It has 2.5 million clients and 5,900 employees. The group holds one-third of the Baltics' banking market and also serves niche segments in Russia. Although HansaBank is a universal bank, its strengths lie in servicing medium-sized companies and private individuals with above-average purchasing power.
It offers a wide range of products from retail banking and corporate financing to life assurance, leasing and investment banking. Its main growth engine is the development of its credit portfolios. Loans grew by 51% in 2004. The bank is also making strong improvements in technology to help create economies of scale. Its internet bank, hanza.net, has more than 1.4 million customers.
The group's success is reflected in its financials. It has a long-term foreign currency rating of A from Fitch. This reflects potentially strong support from its majority shareholder, Swedbank, as well as relatively diversified income sources and conservative risk policies. The challenge going forward will be to ensure that it continues to make sensible lending decisions while maintaining strong growth levels. The group will also need to monitor its increasing exposure to Russia.
Joint Winner Nova Ljubljanska Banka
Nova Ljubljanska Banka is Slovenia's leading bank. Its products include retail, corporate and investment banking. In 2003, the bank and its local subsidiaries had a market share of 37.2% of total assets, 34% of customer loans and 38.2% of customer deposits.
The bank is the biggest institution within NLB Group. It accounts for about 80% of the Group's total assets and loans to non-banking customers. The Group is the biggest banking and financial services organization in Slovenia, with total assets accounting for more than one-third of the total assets of the Slovenian banking sector, encompassing 19 banks. The Group has more than 50,000 corporate and 70,000 retail customers in Slovenia alone.
The bank was founded in 1994. Over the past three years the bank has invested in a number of different areas, especially in IT. NLB developed a new IT platform in 2002 and in the same year introduced mobile phone banking. The following year the bank restructured its organization, breaking its business into five segments.
In 2003, the bank also created a life assurance company, NLB Vita, a joint venture with Belgian institution KBC, which holds a 34% stake in NLB. Within the first six months of its operations, NLB Vita achieved a 4% market share in life assurance. Last year, the bank began offering asset management services through NLB Skladi, a 100%-owned NLB subsidiary.
The bank is one of the highest rated in central and eastern Europe. Moody's, for example, rates it A2 and Fitch, A-. Last year, Marko Voljc, the bank's long-serving president, left to join KBC. Marjan Kramar replaced him.