Car factory in Hungary, where the six largest foreign-owned banks pledged to maintain their overall exposure (photo: Newscom)
GLOBAL ECONOMIC CRISIS
But this series of meetings, aimed at preventing foreign-owned banks from pulling out of emerging Europe, has played a vital role in helping avert a systemic crisis. So far, 15 parent banks have made specific rollover and recapitalization commitments in five countries—Bosnia, Hungary, Latvia, Romania, and Serbia—all of which have stabilization programs supported with funding from the IMF and, in some cases, the European Union.
In this interview, two of the key players, Erik Berglöf, chief economist at the European Bank for Reconstruction and Development (EBRD), and Anne-Marie Gulde, senior advisor in the IMF’s European Department, discuss the impact of the initiative, known informally as the “Vienna Initiative” because of where the first meetings were held.
A crisis waiting to happen
When the global financial crisis swept the world in 2008, many countries in emerging Europe proved vulnerable because of high levels of private debt to foreign banks and foreign-currency exposure.
Policymakers in the region became increasingly concerned that foreign-owned banks, despite their declared long-term interest in the region, would seek to cut their losses and run. The banks themselves were also getting worried: Uncertainty about what competitors were going to do exacerbated the pressure on individual banks to scale back lending to the region or even withdraw, setting up a classic collective action problem.
Under these circumstances, bank behavior was clearly key to macroeconomic stability. Previous crises had amply demonstrated that unwillingness by foreign banks to roll over loans and maintain trade and other credits has the power to precipitate sovereign defaults and currency runs. A sudden outflow of capital from emerging Europe therefore clearly had the potential to escalate into a full-blown balance of payments crisis with potentially devastating consequences for countries there, especially those already hard hit by recession.
Addressing the collective action problem
In the face of these risks, the European Bank for Reconstruction and Development (EBRD), the IMF, the European Commission, and other international financial institutions initiated a process aimed at addressing the collective action problem. In a series of meetings, the international financial institutions and policymakers from home and host countries met with commercial banks active in emerging Europe to discuss what measures might be needed to reaffirm their presence in the region in general, and more specifically in countries that were receiving balance of payments support from the international financial institutions.
IMF Survey online: Erik, your organization, the European Bank for Reconstruction and Development, was among those that launched this initiative. What prompted you to act?
Berglöf: To understand what happened during the crisis, we need to take one step back. In the years preceding the crisis, an economic growth model, based on close financial integration, developed in Europe. But this growth model did not respect the eurozone borders, so when the crisis hit, there was no institutional framework—even within the European Union—for coordinating a response.
The crisis led to all kinds of unintended and complex spillover effects between countries, between banks, and between the private and public sector. To give you just one example, there were intense discussions about whether Austrian taxpayer money should be used to bail out subsidiaries in Ukraine.
There were many other such issues. Bank support programs in western Europe were initially often restricted in how funds could be used to support subsidiaries in eastern and central Europe. Host countries tried to limit refinancing and prevent subsidiaries from transferring funds to their parent banks. There were programs being implemented to guarantee bank deposits in western Europe that attracted deposits from eastern Europe.
"When the crisis hit, there was no institutional framework—even within the European Union—for coordinating a response."
On top of that, there was the private sector dimension. As you know, this crisis essentially originated in the private sector. Much of the debt had been built up by private banks and corporations, and in order to assess the viability of a country’s balance of payments, we needed to at least establish a dialogue between the private and public sectors. In the home countries, such a dialogue had started, but it wasn’t working in the host countries where the pressures were felt most acutely. So we needed to get a conversation going as well between the foreign subsidiaries, the domestic banks, and the government.
Finally, and perhaps most important, was the need for coordination within the banking sector itself. We knew that there would be deleveraging: debt levels had to come down. In the face of uncertainty, as a bank, you would want to be the first to exit in such a situation, even if it’s just to avoid being locked in after everybody else has left. But banks have a long-term interest in the region, and so they were interested in assurances that others were also not planning to run.
So there was a classic collective action problem, and that’s what the Vienna Initiative, now known as the European Bank Coordination Initiative, was all about tackling.
IMF Survey online: Anne-Marie, from the IMF’s perspective, what were the benefits of getting involved?
Gulde: As you know, the IMF is deeply involved in central and eastern Europe. Since the crisis started, the Fund has extended loans worth more than $160 billion, most of them to that part of the world. Most of the region’s debt is to private banks, mostly western European parent banks of subsidiaries active in emerging Europe. That meant we had every incentive to have a dialogue with the private banks in the region. If the banks weren’t willing to roll over their loans, recapitalize their subsidiaries and more generally maintain their exposure to the region, it would have been difficult to avert a systemic crisis, even with the loans provided by the IMF, the European Union, and other multilateral and bilateral lenders. In fact, those funds would have served only to bail out the private sector, replacing private debt by public sector debt, and done little to help the countries back on their feet, if we hadn’t acted.
"If the banks weren’t willing to roll over their loans, recapitalize their subsidiaries and, more generally, maintain their exposure to the region, it would have been difficult to avert a systemic crisis."
The balance of payments situation in the hardest hit countries was critically dependent on how much rollover you would get from the private sector. In both Hungary and Latvia, we had received letters of commitment from the individual banks stating that they were going to be staying in these markets before these two countries’ programs went to the IMF’s Executive Board for approval. But while these letters were public knowledge (in most cases posted on banks’ websites), we knew they were rather general and thus provided only weak signs of commitment.
That’s why we were eager to find a way for a more formal process to keep banks engaged. In the first Vienna meeting in January 2009 we essentially started with a tour d’horizon of the problems. The second meeting was more concrete, aiming to define a framework that would allow banks to make more specific commitments.
"The balance of payments situation in the hardest-hit countries was critically dependent on how much rollover you would get from the private sector."
The real breakthrough came in the cases of Romania and Serbia, where the IMF had just finished negotiating two new programs. With some improvisation, the members involved in the initiative got together to organize country-specific meetings that brought together parent banks with international financial institutions and home and host supervisors.
These meetings linked, for the first time, macroeconomic support by the multilateral organizations directly to specific commitments on rollover and recapitalization. They also helped develop a template for commitments and procedures that was followed, to a large extent, in subsequent country meetings.
Since that first meeting, country meetings have been held for Bosnia, Hungary, and Latvia—all of which have IMF-supported programs in place. To keep banks informed and committed, a follow-up meeting has taken place with Romania, and others are likely to take place once program reviews take place.
IMF Survey online: How successful has the initiative been at stemming the crisis in central and eastern Europe?
Berglöf: It may be too early to say how well it will work in the future, but it did play a role in stabilizing the situation, and it certainly created a dialogue between the private and public sectors.
If you look at the history of previous bank rollover initiatives, in Turkey in 2001, during the Asian crisis in the late 1990s, and in Brazil in 1999 and 2002, it is not uniformly encouraging. What has worked here, at least for now, is that the rollover rates are still high. And we haven’t seen any bank failures among the foreign-owned banks—so far, all bank failures have been domestic.
As I started out by saying, the growth model involving close-knit financial integration between emerging and advanced Europe was very beneficial, notwithstanding the crisis. There is a lot of evidence suggesting its positive impact on economic growth. What was missing was a framework to protect it. Now, we have created at least the scaffolding for such a framework.
But there are still a lot of things left to do. We need to address the remaining foreign exchange exposures, for instance. We also think the initiative could help build up local capital markets and could be used as a platform for addressing some of the debt restructuring issues, but obviously we need to discuss this with the other partners involved in the initiative. Right now, the focus is on the financial sector, but there are huge challenges waiting to be addressed in the corporate sector as well.
Gulde: The initiative has played an important role in helping settle market expectations. We have seen very high rollover rates in all program countries, as Erik said. In Hungary, rollover rates initially even exceeded 100 percent. In other countries, we are slightly below 100 percent.
Equally important is the fact that the initiative has provided a platform for dialogue, thereby creating a degree of certainty in private markets that has been beneficial for the economic policies of the countries in question. So the impact of the initiative actually goes far beyond the banking sector.
"The initiative has played an important role in helping settle market expectations."
But of course, there is no way of knowing what would have happened in the absence of the initiative. I believe the banks when they say they wouldn’t ‘just run away’, because they have invested a lot in brick and mortar. Nevertheless, when we met the banks they clearly emphasized how important it is for them to know the macroeconomic parameters, to have a degree of certainty about where the country is heading, and what economic commitments it has made. Knowing the broad economic framework makes for a more predictable business strategy.
Still, the level of activity going forward will be a lot lower, and the banks will need to reshape their business models, so we are not out of the woods yet.
Comments on this article should be sent to imfsurvey@imf.org
