Central Europe's banking sector is the young growth industry in Europe's financial scene. Well performing economies, increasing wealth and an under-banked population are the ingredients for a healthy prognosis for the next few years. But problems with the institutional environment remain and could increase, should macroeconomic growth disappoint.
Incomes in central Europe are expected to double over the next 10 years, as countries catch up with overall EU levels. Monetary wealth held in financial assets is small, standing at €2,400 per person, only 8% of the eurozone average. Personal loans are also growing from very low levels, about 12% of GDP, compared with 49% of GDP in the euro area.
Consequently, banks are focusing on the retail side of their business and the provision of personal loans, which increased by 20% a year over the past three years. "Banks are expanding retail lending, because margins are higher. But corporate lending is still the larger proportion on banks' balance sheets," says Alwin Greder, associate director in S&P's financial services group.
Strong competition has led institutions to develop more sophisticated lending products and to modernize their distribution channels. Mortgage lending is also booming, although legal and regulatory issues still present hurdles. "Over the medium term, we expect this to develop quite nicely," says Greder.
But branching out into other areas of financial services is proving harder. Despite healthy liquidity levels, banks do not engage in any securities trading, (except for government bonds) or foreign exchange activities. In the bigger countries, such as Poland and the Czech Republic, asset management and mutual fund investment is slowly becoming established, but overall remains scarce. The region's capital markets also need a boost.
Despite the focus on the traditional business of accepting deposits and providing loans, banks in central Europe continue to operate more profitably than those in western Europe. The average return on assets in the region is 1%, compared with 0.4% in the west. High profitability and scope for further efficiency improvements has attracted the interest of foreign banks, which have become heavily involved in the area.
The privatization process has been completed in most countries of the region and the presence of foreign players is high. In Poland, foreign investors represent nearly two-thirds of the sector's assets. Foreign expertise and capital have been crucial to the positive development of the financial industry in the region.
However, the banking industry in central Europe remains relatively small. About 300 banks operate in the region, with overall assets of €350 billion, the equivalent of 2.4% of total assets of all banks in the euro area. A handful of big institutions dominate the market and concentration (the market share of the five biggest banks) is higher than in the rest of Europe, 64% compared with 52%.
Continuing problems in the institutional environment, such as low enforceability of claims and delays in bankruptcy and liquidation procedures, exist. "We are still talking about underdeveloped economies," says Greder. But in terms of economic expansion, central and eastern Europe is expected to beat their western neighbours. GDP growth is anticipated to exceed 4.4% until 2007, compared with less than 2% for the established EU countries.