Role of Company Secretary in Bank Governance

Corporate Governance of Banks in Eurasia

Dr Sibel Beadle, Principal Banker, EBRD Role of Company Secretary in Bank Governance London, United Kingdom 30 April 2008 The views expressed in this paper are those of the author and do not necessarily represent the opinions of the OECD or its Member countries or the European Bank for Reconstruction and Development Impact on EBRD Countries of Operation

 Sub prime Exposure – What Happened? – Exposure of Financial Sector in EBRD Countries of Operation

 Liquidity Squeeze – Vulnerability – Credit growth and Dependence on External Funding in EBRD Countries of Operation – Alternative Funding Sources? How did the sub prime crisis start?

 Initially – US housing prices, started to fall and sub prime mortgage borrowers started to default

 First half of 2007 – Acknowledgement from the FED that the broad based defaults could lead to $50 Billion of write downs

 August 2007 – Crisis became visible when ECB had to inject the first Euro 95 Billion into money markets Current Level of Write Downs

Mortgage Related Write-Downs (91 financial companies, 177bn)

$40,000 UBS $35,000

$30,000 Citi $25,000 Merrill SocGen $4bn

$20,000 UniCredit $0.8bn RZB $0.04bn $15,000 Morgan Stanley $10,000

$5,000

Source: Moody's and BBC How large are the losses?

 Still uncertain

 First week of February – Tokyo meeting – German Finance Minister revealed that the G7 thought losses could reach $400 bn

 New write-downs since February How could this happen?

 October 2007 Fitch announces – 26% of downgrades from all rated 2006 sub prime RMBS – Many from investment grade to speculative grade

 January 2008 Moody’s announces – Downgrades on 53.3% of the 2006 vintage tranches (representing 93.4% of the deals backed by first- and second-lien sub prime mortgages) – Downgrades on 38.2% of rated tranches of the 2007 vintage

 February 2008 S&P announces – Downgraded $183 billion out of $3.24 trillion in original issuances (an additional $588.31bn put on credit watch – Securities that S&P downgraded from investment grade to speculative- grade did account for about 63% of the downgrades by original issuance volume

 Downgrades are still continuing… What does this mean concretely— Structured Finance Rating changes S&P

BBB CCC AAA AA+ AA AA- A+ A A- + BBB BBB- BB+ BB BB- B+ B B- + CCC CCC- CC D

AAA 83.6 0.7 1.3 0.4 0.7 0.6 0.6 0.5 1.0 0.9 0.5 1.5 0.3 0.25 1.08 0.47 0.96 1.1 1.86 1.3 0.39

AA+ 84.6 2.1 0.7 0.9 1.5 0.3 0.4 1.9 0.1 0.4 2.5 0.04 2.63 0.09 0.09 1.23 0.04 0.18 0.04

AA 0.1 0.2 74.3 1.4 1.1 2.0 1.0 0.7 2.0 0.6 0.7 2.9 0.2 0.28 2.81 0.35 0.64 4.56 1.23 2.55 0.4

AA- 0.1 0.5 62.4 1.8 1.7 0.9 1.0 2.0 0.8 0.5 3.0 0.3 0.22 7.55 0.22 0.34 13.32 0.84 1.9 0.62

A+ 56.8 1.4 1.5 1.6 2.3 0.9 0.9 3.4 0.4 0.33 3.32 0.44 0.16 23.58 0.65 1.69 0.54 A 0.1 0.0 0.1 61.3 1.7 1.4 2.6 1.1 Downgrades1.1 3.4 0.5 0.84 2.25 0.49 0.35 14.01 1.44 6.07 1.13 A- 0.1 47.9 2.9 3.3 1.3 0.7 4.0 1.1 0.6 3.79 1.02 0.23 23.14 0.88 7.45 1.67

BBB+ 43.2 2.4 2.3 1.8 4.9 1.2 0.97 4.56 0.92 0.15 25.72 0.36 8.66 2.87

BBB 0.0 0.1 0.0 52.8 2.4 2.6 4.4 0.8 0.97 4.63 0.73 0.32 14.46 1.67 11.71 2.37

BBB- 0.1 0.0 38.4 2.3 4.8 1.4 0.85 6.26 1.38 0.08 23.54 0.28 16.3 4.27

BB+ 24.9 2.5 1.4 1.06 5.42 1.36 23.91 0.48 26.52 12.49

BB 0.1 0.1 56.2 2.2 0.82 12.73 0.92 0.05 12.84 0.27 9.09 4.79

BB- 64.4 4.7 9.4 2.01 10.07 4.03 5.37

B+ 1.8 85.45 9.09 3.64

B 0.09 69.84 5.29 23.1 0.09 0.88 0.71

B- 83.3 2.08 12.5 2.08 Impact on EBRD Countries of Operation

 Sub prime Exposure – What Happened? – Exposure of Financial Sector in EBRD Countries of Operation

 Liquidity Squeeze – Vulnerability – Credit growth and Dependence on External Funding in EBRD Countries of Operation – Alternative Funding Sources? How is the liquidity squeeze connected to the sub prime

 High uncertainty in financial markets – Increased risk aversion – Initial uncertainty on exposure caused spill over to all markets – Spreads widened, funding has become expensive and sometimes was not available any loner

 Funding problems in EBRD countries where rapid credit growth was heavily reliant on external funding Differences of Western World vs. EBRD Countries of Operation

Western Markets: Rest of the World:

Liquidity Problems Asset Problems Worldwide incl. EBRD countries

- Could lead to asset problems over time - Uncertainty in markets led to difficulty in raising external funds Risk Categories among EBRD Countries of Operation

 High risk factors: – High credit growth mainly driven by wholesale funding—For example, banks in Kazakhstan (the worst hit country by the liquidity problem) and the banking system in the Baltic Countries – Banking systems that do not have a sufficiently diversified funding base; in particular, those with a weak deposit base – Countries that face other macro economic or financial problems (high deficits, large external imbalances, pressure on currency, housing bubble) are likely to be worse affected by the credit squeeze

 Risk mitigating factors: – Strong foreign exchange reserves—determined intervention by a central bank backed by strong foreign exchange reserves – Strong presence of foreign banks—particularly, if the parent is willing and able to provide liquidity support – Strong deposit base of the banking system

 However, even in banking systems with high deposit levels deposits can move to large systemic banks or state banks—flight to quality/government guarantee

 Or in countries with low level of deposits individual banks can have a strong customer base Financial Intermediation and Credit Growth

Financial Intermediation – Bank Credit to Private Sector/GDP) (2004 vs 2007) 200

180 Baltics

CIS 2007 160 EU 140 SEE ETC 120 2004

100 2007

2004

Credit/GDP (in Credit/GDP Percent)

2007

2007 2007

60 2007

2007

2004

2007 2007

40 2007

2007

2004

2007

2004

2007

2004

2004 2007

20 2004

2007

2004

2007

2004

2007

2004

2007

2004

2004 2004 0 2004 By Region

Change in Bank Credit to Private Sector/GDP Baltics BPS (2004 - 2007) 60 CIS 50 40 CE 30 SEE 20 ETC 10

Czech

Latvia

Serbia

Russia

France

Poland

Croatia

Estonia

Georgia

Ukraine

Hungary

Armenia

Slovakia

Slovenia

Bulgaria

Moldova

Romania

Lithuania

Kazakhstan

Azerbaijan Macedonia Deposit Base by Region

Figure 2: Customer Deposits/Total Bank Assets (2007*)

90% Baltics 80% CIS 70% 60% CEE 50% SEE 40% ETC 30% 20%

10%

Czech

Latvia

Kyrgyz

Serbia

Russia

Bosnia

Poland

Croatia

Estonia

Belarus

Ukraine

Georgia

Albania

Armenia

Hungary

Slovenia

Slovakia

Bulgaria

Romania

Moldova

Lithuania

Tajikistan

Azerbaijan

Macedonia

Kazakhstan Montenegro

Source: CEE Banking Sector Report; EBRD; Fitch Ratings. * or latest available Foreign Ownership

% Figure 3: Foreign Ownership (% of total assets)

100 Baltics

80 CIS CEE 60 SEE 40 ETC

Czech

Russia

Latvia

Poland

Bosnia

Serbia

Croatia

Estonia

Belarus

Georgia Ukraine

Slovakia

Hungary

Bulgaria

Armenia

Lithuania

Romania

Slovenia

Azerbaijan Kazakhstan Source: CEE Banking Sector Report; EBRD; Fitch Ratings Increase in the Cost of Risk at the Country Level

CDS, 5 Year Default, Foreign Currency Bps 350 x2.1 300 x5.6 x1.7

250 x4.5 x9.6 200 x28.4 x3.6 150 x5.3 x17.0 x2.2 x7.7 100

50 x2.9

0 Kazakhstan Ukraine Russia Poland Hungary Estonia

31 December 2006 31 December 2007 Peak Now, 29. April 08 Liquidity and Funding By Region -- Baltics

 The largest vulnerability of the Baltics region is stemming from extraordinarily rapid credit growth prior to the credit squeeze

 Depositor base of the Baltic countries is not as strong as in some other regions; only 50% of funding is provided by customer deposits.

 Foreign ownership – high, but strategics have higher funding costs Liquidity and Funding By Region - Baltics

 The largest vulnerability of the Baltics region is stemming from extraordinarily rapid credit growth prior to the credit squeeze

 Depositor base of the Baltic countries is not as strong as in some other regions; only 50% of funding is provided by customer deposits.

 Foreign ownership – high, but strategics also have higher funding costs

 Overall, the majority of banks in the Baltics are controlled by Scandinavian banks—slow down in the Baltics would impact profitability of Scandinavian banks and increase of funding costs of the parent would influence profitability and growth of banking in the Baltics – For example, currently 15 % of Swedbank’s total lending and more than 30% of its operating profit is stemming from Swedbank’s Baltic banking operations – Swedbank’s wholly owned subsidiary Hansabank is the market leader in Estonia, Latvia and a major player in Lithuania. – S&P to revise the outlook of Swedbank to negative from stable on December 18, 2007.

 Fitch ratings changed the outlook for Latvia and Estonia to negative on January 31, 2008; prior to that Fitch had downgraded Latvia to BBB+ on August 17, 2007) Liquidity and Funding By Region – CEE/SEE

 Credit growth in EBRD countries that are a part of the EU have been moderate compared to other regions—The high growth countries among the EU countries were Bulgaria and Slovenia.

 Bulgaria as well as Slovenia has a very strong customer deposit base and customer deposits make up about 80 percent of total assets of the banking sector--except for Hungary for all countries in this group more than 50 % of funding comes via customer deposits

 Foreign ownership is very high, often above 80

 However, large variations in concentration of ownership. In some of the countries the presence of foreign banks is concentrated among a few large strategics. For example: – Czech Republic, the three largest banks CS (Erste), CSOB (KBC), KB (Soc Gen), make up more than 50 percent of the banking sector assets – Poland, other than UniCredit which owns Bank Pekao and Bank BPH (2nd and 3rd largest banks in the country), none of the foreign strategics have a larger than 7 percent market share

 Therefore, the impact of the liquidity crisis in this region is rather complex and can often be influenced by: – changes in the funding conditions of a few strategics – or can be largely biased by strategic decisions—For example, in some of these countries, due to the competition among large international banks to retain or increase market share the increased funding costs have not been fully passed through to the end consumer, yet. CEE/SEE

Figure 5: Foreign Ownership--Parent Bank (Percent of Total Banking Sector Assets)

100% Other Foreign 90% Bayern LB 80% 70% Intesa 60% KBC 50% SocGen 40% 30% RZB 20% UniCredit 10% Erste 0%

Source: EBRD, Monitoring Reports, Raiffeisen, CEE Banking Sector Report Wholesale funding of the Strategics

Selected European Banks: Dependence on wholesale financing as of March 2008

70 Dexia

60 Nati

50 Unic Raiff Dansk Swedbank Handel Norde 40 Sanp SEB BBV Rabo 30 DnB Sant Erst

loans loans (%) 20

0 5 10 15 Ratio Ratio of outstanding debt securities to total Average debt maturity in years Source: GFSR, April 2008, IMF, page 26 Original Sources: Bloomberg L.P.;Thomson Worldscope;and IMF Liquidity and Funding - Kazakhstan

 Kazakhstan has experienced one of the most exuberant credit growths prior to the liquidity squeeze—The sudden drying up of world wide credit in August led to a large disruption in the banking sector. – Rapid growth in private credit was mainly funded by external credit. – Further, the deposit base of banks was one of the weakest among the countries of operation – Relative limited foreign ownership at the time, banks also had little alternative funding source

 Nonetheless, the relatively strong FX reserves and the ability and willingness of the Kazakh authorities to intervene were very important in fending off the immediate distress situation that was created in August and September 2007.

 Even in the case of Kazakhstan, which was the most affected country in the region, the rating for the country itself and for individual banks did not change materially, reflecting the very strong fundamentals the region has compared to historic episodes of financial turmoil Liquidity and Funding - Russia

 Among the CIS countries, Russia—while not immune—compared to other CIS less vulnerable to the liquidity squeeze (moderate to high credit growth)

 Extraordinary FX reserves – key role in providing great credibility to the Russian central bank during the height of problems – was also recently acknowledged by S&P and led to a change in the outlook for the Russian sovereign to positive from neutral on March 11 2008

 However, weaknesses in the funding base of banks exist – Funding to small and medium sized banks is severely restrained – Lowest ratio of customer deposits to total banking sector assets (among EBRD countries) – Low foreign ownership of banks – Government support for the smaller banks’ is likely to be less than the large players in the market.

 Liquidity squeeze may accelerate consolidation in the banking sector, including potentially greater concentration towards the state sector

 One distinct difference in Russia, compared to many other EBRD countries of operation, is that driven mainly by the strong oil prices and the solid economic growth, the corporate sector is still strong – corporate as well as retail customers continue to ask for loans – Banks (unlike in some other markets) can pass on the additional cost of funding to the customer, since the end customer is able as well as willing to pay for the higher cost. FX Reserves of Russia

Foreign Exchange Reserve of Russia are Exceptionally

Strong driven by High Oil Prices

5.00E+11

4.50E+11 RUSSIA 4.00E+11

3.50E+11

3.00E+11

2.50E+11

2.00E+11

1.50E+11

1.00E+11

5.00E+10

0.00E+00 Liquidity and Funding By Region -- ETC

 High credit growth but driven by low base

 Resilience compared to historic experience

 Going forward: – Liquidity squeeze is likely to slowdown growth in banking sector – Slowdown in world GDP growth likely to impact region Thank you!