The financial crisis has provided a stern test for international banking – one that has produced mixed results. On the one hand, in countries where foreign banks had a leading position they often continued to be stable credit sources (Claessens and van Horen 2012a and 2012b). On the other hand, subsidiaries of international banks that are now in trouble at home have reduced lending earlier and faster during the crisis when compared with local banks (De Haas and van Lelyveld 2011a and 2011b).
One region where foreign banks dominate the financial landscape is emerging Europe (Figure 1) and this column analyses bank lending behaviour in this part of the world during the crisis. We pay special attention to the impact of the Vienna Initiative, a public-private partnership that was established towards the end of 2008 to safeguard financial stability in emerging Europe.
Figure 1. Foreign banks around the world
Note: Foreign-bank assets as a percent of total banking assets
Source: Claessens and van Horen (2012a); EBRD.
At the height of the 2008–09 crisis, it became increasingly uncertain whether foreign banks would continue to fund eastern European customers through their local subsidiaries. The fear was that while it would be in the collective interest of banks to roll over debt to emerging Europe, the absence of a coordination mechanism could lead individual banks to withdraw, ultimately causing a ‘run’ on the region. The accompanying decline or reversal in financial flows would not only have had dire consequences for local firms and households but also have led to large exchange-rate fluctuations and balance-of-payment problems.
These concerns were exacerbated when some Western governments started to financially support banks towards the end of 2008. This alleviated concerns about a credit crunch ‘at home’ but did not reduce worries about a retrenchment of multinational banks from emerging Europe. On the contrary, concerns were raised that government support came with ‘strings attached’ and that banks were asked to focus on domestic lending.
What was the Vienna Initiative?
In November 2008, a number of banks with a large presence in emerging Europe sent a letter to the European Commission to call for a quick and coordinated response to the problems in emerging Europe and, more specifically, to ensure sufficient funding for banks operating in the region. In response the Vienna Initiative was created as a coordination platform for multinational banks, their home- and host-country supervisors, fiscal authorities, the IMF, and development institutions to safeguard a continued commitment of parent banks to their subsidiaries and to guarantee macroeconomic stability in emerging Europe.
In February 2009, the European Bank for Reconstruction and Development, the European Investment Bank, and the World Bank Group launched, within the context of the Vienna Initiative, a “Joint IFI Action Plan in support of banking systems and lending to the real economy in Central and Eastern Europe” with the objective “to support banking sector stability and lending to the real economy in crisis-hit Central and Eastern Europe” (EIB 2009). During spring 2009, these institutions met several times with 17 banking groups and a ‘joint needs assessment’ resulted in financial support packages for these banks.
This support was integrated with IMF and EU macro-financial support programmes to Bosnia and Herzegovina, Hungary, Latvia, Serbia, and Romania. In return for these countries’ commitment to keep their programmes on track and for financial support, various multinational banks signed country-specific commitment letters in which they pledged to maintain cross-border exposures and to continue to provide credit to firms and households. Banks confirmed that they would keep subsidiaries adequately capitalised and sufficiently liquid.
At the time concerns were expressed that the focus of these commitment letters on five countries could tempt multinational banks to support these countries by withdrawing funds from countries without exposure commitments (such as Poland and the Czech Republic). Such negative spillovers could even have contributed to the cross-border transmission of the crisis.
Did it work?
Although a large-scale, uncoordinated withdrawal of banks from emerging Europe did not materialise – and the Vienna Initiative can therefore be considered successful in a strict sense – virtually no empirical evidence is available on its impact. In a recent working paper (De Haas et al 2012) we provide some such evidence, based on a comprehensive bank-level dataset. Our findings are as follows:
- In 2008, before the Vienna Initiative began, bank lending dropped significantly more in (future) Vienna Initiative countries compared to non-Vienna Initiative countries. On average, the adjustment in credit growth was about 14 percentage points sharper in the five countries that would need to be supported by the IMF and EU a year later. In 2009 – when the credit crunch intensified on average – Vienna Initiative countries ‘normalised’ and the credit decline became more in line with other countries in the region.
- During 2008, foreign banks were the first to curb credit growth, bringing it back in line with that of private domestic banks. Domestic bank lending mainly slowed down in 2009.
- In a panel-data analysis we show that credit growth of foreign banks that were part of the Vienna Initiative was about ten percentage points higher in 2009 compared to other banks (all else equal). In a cross-sectional analysis we confirm a positive relationship between parent banks signing a commitment letter in a specific country and credit growth of their subsidiary in that country in 2009. We do not find a separate impact of government support on the growth of bank lending.
- When a parent bank did not sign a commitment letter in a particular country but did do so in another country, we do not find any negative impact on lending in the non-signing country. It is therefore unlikely that Vienna Initiative banks propped up their lending in Vienna Initiative countries, as per the signed commitment letters, by reducing their lending elsewhere in emerging Europe. If anything, we find a positive spillover effect.
Overall, our evidence suggests that participation in the Vienna Initiative may have helped banks to stabilise their lending. Importantly, we find no evidence of negative spillovers to other parts of emerging Europe. Complementing public funds by a coordinated bail-in of private-sector lenders may not only have helped countries to close external funding gaps, but also to soften the inevitable deleveraging process in emerging Europe and to prevent a uncoordinated ‘rush to the exit’.
The ad hoc nature of the Vienna Initiative highlights that international coordination mechanisms as they had existed before the 2008–09 crisis turned out to be insufficient during the crisis. While subsequent improvements have been made, the recent Eurozone debt crisis has shown that policy coordination between home- and host-country regulators and supervisors still leave much to be desired. When exposures to sovereign risk in the Eurozone periphery brought about a deleveraging process as of summer 2011, the need was felt to once more step up the coordination between banks and their home and host-country supervisors. This initiative was dubbed Vienna 2.0.
As part of Vienna 2.0, principles to avoid disorderly deleveraging in emerging Europe were agreed by officials and private-sector banks in Brussels in March 2012. The agreement aims to achieve better (ex ante) coordination between banking-sector regulation and supervision and to contain negative spillovers between the Eurozone and emerging Europe. Such improved coordination and information-exchange is not only necessary to prevent spillovers of financial shocks, but also because the alternative –forcing highly integrated pan-European banking groups to hold significantly more capital and liquidity in each and every individual subsidiary – could turn out to be very costly.
Claessens, S and N van Horen (2012a), “Foreign Banks: Trends, Impact and Financial Stability”, International Monetary Fund Working Paper 12/10.
De Haas, R and I van Lelyveld (2011a), “Multinational Banks and the Global Financial Crisis: Weathering the Perfect Storm”, EBRD Working Paper No. 135, European Bank for Reconstruction and Development, London.
EIB (2009), “Joint IFI Action Plan In Support of Banking Systems and Lending to the Real Economy in Central and Eastern Europe”, EIB, EBRD, and World Bank, 27 February.