Solving Croatia's banking crisis

Knett: long-term bull on Croatia

Dedic was notorious for his forceful approach to banking. "He showed very strong behaviour towards his clients," says an analyst. "If they couldn't repay they were kept in the bank for up to two days." Most prominent banks tried to keep their distance from Dedic and his business. On July 22, the Croatian central bank ordered Promdei Bank to appoint a temporary deputy to replace Dedic, after operating difficulties began to emerge and the bank proved incapable of making payments. The police are still investigating Dedic's death.

Promdei is a particularly troubled example of a general banking crisis. Croatia is also confronting a looming recession and has been seriously affected by the war in neighbouring Kosovo. The conflict has resulted in an estimated 30% to 50% reduction in this year's revenues from tourism, an important sector in Croatia, and has further damaged the climate for foreign direct investment. The finance ministry has started to rehabilitate banking through stricter regulation, bankruptcy proceedings directed at weak banks and a push to privatize the most desirable state-owned assets. But its approach has been criticized for being old-fashioned, too guarded and much too late in being implemented.

Rocked by crises

Several problems have hit Croatia in quick succession. First there was the Asia crisis, then the Russian devaluation. Neither had a direct effect but both harmed investor sentiment. There followed a very strict monetary policy from the central bank aimed at stopping depreciation of the kuna against the Deutschmark. Liquidity has contracted and many companies that leveraged their balance sheets during better times are now facing collapse. Banks have cut back on lending, intensifying the economic slowdown.

Croatia is overbanked and poor banking practice has been allowed to persist. Five million people are served by more than 60 banks, about three times more than are necessary. Many banks are small and poorly run, partly because operating licences have been given out freely. "Many banks don't have any target," says one analyst. "People just get together and say 'let's start a bank'. They are just a trading company to make money. They are not really banks." Promdei Bank has a slogan that perhaps sums up this naive approach: "The possibilities are enormous. Let's make money together."

Banks' accounting procedures are so inadequate that it is difficult for the central bank, let alone outsiders, to determine many firms' true condition. Moody's analyst Pavel Simacek says the central bank has still not supplied him with last year's annual results from Croatian banks. Non-performing loans are a problem, but no-one knows their extent because figures are not forthcoming. Moody's uses figures for Zagrebacka Bank, which has the most transparent balance sheet, as a proxy for the sector. Zagrebacka reports 13.8% of loans as non-performing but as it is Croatia's leading bank, the figures for other banks undoubtedly are more alarming.

Struggling to survive

Reckless borrowing has not been monitored. "There are a lot of problems with banks' founders," says Nikola Carevic, managing director of Deutsche Bank's representative office in Zagreb. "The shareholder does not think of himself as a shareholder but a credit holder." Using the credit of banks under dozens of different names has been a continuous problem.

Many banks are now in trouble. Splitska Bank, one of the banks that the government has decided is worth saving, pitifully describes its struggle to stay afloat in a public pronouncement: "We went through many changes, we experienced the collapse of economy [sic], we experienced all difficulties resulting from an unstable currency, we looked for a way out escaping into foreign currencies, our inflation was measured by thousands of index points and we finally reached the huge wall of blockade, insolvency and illiquidity." A similar story could be told by most of the nation's domestic banks; all but one of the large ones have faced rehabilitation of some kind.

Everyone agrees that banking consolidation needs to be swift and drastic if the sector is to be saved. "The banking sector is slowly but surely going bankrupt," according to an analyst. "The government should start with a concentration process by whatever measures, whether it be bankruptcies, mergers or forming banking groups. There should be a concentration on domestic banks with some strong regional players because there is not enough [room] for everyone."

The banking crisis peaked at the end of last year and the government has since intervened to contain it. The key reforms have been stricter rules on bankruptcy procedures, stiffer loan-provisioning requirements and a ban on inter-group lending. The central bank now wields much stricter control and direction over banks.

On paper, the new regulatory framework seems strong enough to punish banks that break the rules but there is concern over whether it will work. It now has to be implemented by the banks. The bureaucratic legal system could make enforcement difficult and protracted. "The legal system is fantastic, not quite as fantastic as Moscow but close," says an analyst. "The average lifetime to make a decision is six to eight years."

Eleven banks, including Dubrovacka Bank and Glumina Bank, are now under forced government control and are at various stages of rehabilitation or pre-bankruptcy. Three others - Rijecka Bank, Splitska Bank and Privredna Bank - are in the final phase of rehabilitation and are scheduled for privatization. The state owns 70% to 80% of each of these banks and is looking for a strategic foreign shareholder for a partial stake. Foreign advisers have been appointed for each bank: ABN Amro for Privredna, Daiwa Bank for Splitska, and Deloitte & Touche and HSBC for Rijecka. Some Italian banks, such as Banca Commerciale Italiana, have shown an interest in Splitska and Rijecka. Austria's Raiffeisen ZentralBank (RZB) has expressed an interest in Rijecka and formal proceedings were due to begin in September.