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THE SITUATION OF banks in emerging markets varies with the region. The concept of emerging markets for the banking industry is becoming increasingly hard to define as a general category.
Central and eastern European banking systems are increasingly integrated in the EU mainstream – even in those cases where accession to the EU is not imminent. Important segments of Latin American banking are now in the hands of large global banking groups, primarily from Spain and the US.
In the Middle East, fears about major banking difficulties linked to the Iraqi war did not materialize. Russia remains an economy with an underdeveloped banking system, but progress is on its way.
With the Argentine and Uruguayan banking systems still devastated from recent external payments crisis, the Andean systems either reeling from macroeconomic uncertainty (Venezuela and Ecuador) or slowly digging themselves out of recession and financial sector stress (Colombia, Bolivia, and Peru), the most compelling banking system story in Latin America is that of the contrasting system evolutions in Mexico and Brazil.
The recent history of these two banking systems – in countries with more than 75% of Latin America’s GDP and more than 270 million people – could not be more different. Brazil is characterized by strong and agile indigenous private banks and an important state-owned component that have been able to fend off foreign incursions into their market. Mexico’s system almost succumbed during the 1995 banking crisis, and has been essentially sold off to foreign multinational banks.
Up until three years ago, the largest privately owned Brazilian banks benefited from strong intrinsic strength with an average Moody’s bank financial strength rating (bfsr) of C+. Meanwhile, the largest Mexican banks, with an average bfsr of only D, were either selling themselves off from a position of weakness or being sold off by the government after official intervention.
A tale of two banking systems
In spite of what appears to be excellent profitability in both systems, the prospects for Brazilian and Mexican banks are now quite different. Brazilian banks, which are large holders of government debt, remain inextricably linked to a delicate and vulnerable sovereign balance. Although the system’s profitability has historically benefited from the volatility of both interest and exchange rates, it has also become increasingly exposed to the frequency and amplitude of both internal and external shocks.
Because of this exposure, there is less than meets the eye when viewing Brazilian private banks’ profitability and outlook. It is for that reason that the largest Brazilian banks’ financial strength ratings have declined to an average rating of below C-, and remain on negative outlook.
In Mexico, the recent internationalization of the system, improved supervision, and a stable economic environment induced by the North American Free Trade Agreement have converged to produce a critical mass of strong banks with rapidly improving financial flexibility.
These developments, combined with a dramatic fall in nominal rates to as low as 6%, and a rapidly improving domestic financial architecture, have conspired to increase the average bank financial strength rating of the largest Mexican banks to slightly above C-, with a generally positive outlook. We believe that there is more than meets the eye in the Mexican banking system. The already mentioned improvements, combined with extremely low intermediation levels to the private sector – private-sector banking assets are approximately 15% of GDP, and only Venezuela has a lower rate in the region – offer enormous profit-making opportunities for Mexican banks over the medium to long term.
The fundamental lesson that comes to us from this tale of two banking systems is that a stable macro environment is the foundation for future bank profitability. Banks may be able to post good profitability without a good environment, but they will remain vulnerable to significant downside risks without macro stability.
Structural progress in CEE
By and large central and eastern Europe (CEE) is a good story for the local banks. The 2002/03 period has brought continuing structural progress, but also cyclical difficulties, primarily for banks in Poland. The EU accession countries in the region (the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia and Slovenia) received ratings upgrades reflecting their closer integration within the European economic framework.
This led to numerous rating upgrades for many banks in those countries – to reflect the expected support from their parent organizations, which are mainly European and US banking groups with ratings in the Aa range.
With only a few major exceptions, most CEE commercial and savings banks are owned by western financial groups. Among the exceptions we can cite PKO BP in Poland, BCR in Romania, NKBM (and partly NLB) in Slovenia, which are all government owned, as well as OTP in Hungary and Parex Bank in Latvia.
By and large western ownership and control have proven highly beneficial to banks in the CEE. They brought expertise, in the form of product knowledge, risk management, or technology. They brought advantages for funding and capitalization, as well as a welcome shield against government interference. These banks’ strategies are now heavily influenced by their parent banks’ priorities – focusing primarily on retail (individuals and small and medium-size enterprises). In a nutshell, these priorities are to minimize risks and maximize returns. In this way, relatively young banking systems – they were in most part born after the collapse of the communist system – are now more firmly anchored to the developed markets in which their parent groups operate, primarily the EU.
In the CEE countries, the local banks are aiming at growing first and foremost their retail activities. The strategy remains largely liability-driven, through an effort to increase the penetration of the individual and business savings markets in countries where banking penetration is still low compared with western Europe. But as the local economies advance and as competition increases, banks in the CEE are increasingly looking at retail loans as well.
National mortgage markets are developing in various forms and under different schemes, for example through government subsidies in Hungary and the Czech Republic, or through funding from the European Bank for Reconstruction & Development in Romania. But consumer lending and card activities are also growing. This trend should bring an additional layer of new credit risk to the banking sector in the CEE, but it seems likely that parent banking groups – which had to face these issues in their own markets years ago – will continue to exert tight controls and to impose their loan underwriting criteria.
The focus on retail business mirrors to a large extent the banks’ parent institutions’ own domestic strategies. Such banks as UniCredito Italiano, KBC, Erste, Citi, Société Générale and HVB/Bank Austria are focusing on retail financial services, some of them at least de-emphasizing to some extent wholesale banking. And these large western groups are understandably reluctant to see significant growth in their CEE subsidiaries’ corporate credit business.
In Poland, the economic crisis of recent years has led to problems in banks’ credit portfolios. Several banks with a presence in the local corporate and SME sectors have suffered, with materially higher provisioning needs and revenue loss. The market is slowly being stabilized, and any further significant declines are unlikely. Overall, though, the health of the Polish banking sector will need to improve significantly.
According to Moody’s assessment (financial strength ratings in the C range, which is the highest for CEE banks), the strongest banks in the region are: OTP and MKB (Hungary), Pekao SA (Poland), Hansabank and Eesti Uhisbank (Estonia), Nova Ljubljanska banka and Nova Kreditna banka Maribor (Slovenia), and CSOB (the Czech Republic).
Russia remains one of the most challenging of all the developing markets. The banking sector has still to recover fully from the traumas of 1998. Now, with the insolvent banks finally disappearing from the system, the mid-sized banks that were least affected by the problems have benefited. However, these were all relatively small banks and, despite 60% plus growth, they remain small. As a result, government-owned institutions continue to dominate, with Sberbank the only bank of really significant size. Also, since it is the only bank with its deposits guaranteed, only the brave are prepared to trust other banks, although quality service and more specialized facilities are beginning to tempt some customers to them. The legislature and the central bank spent much of the past year debating a deposit insurance scheme. But, while it now seems likely that some scheme will be introduced soon, the position of Sberbank remains unresolved and it appears set to continue its advantage for a number of years.
Meanwhile Vneshtorgbank, which is now owned by the finance ministry rather than the central bank, is developing new strategies under a new management team. Promises of privatization still seem some way off as the bank tries to establish a dominant market position in the corporate sector before possible privatization. Although the other major government-owned institution in our list is Vnesheconombank, it does not in fact have a banking licence. Its major business is restructuring and recovering debt owed to Russia by the CIS countries. It has also been given the right to establish a pension fund and is the only government-owned institution to be awarded this privilege. It will compete with around three private-sector institutions for this new business.
Although Gazprombank has said that it will aggressively develop non-Gazprom business, this did not happen in 2002. The march of the private sector has been led by Alfa Bank and MDM Bank. Both institutions have tried hard during 2002 to develop acceptable, non-related-party business and also to make their operations more transparent. Although both have succeeded to some extent, much remains to be done to bring them up to internationally acceptable standards.
Kazakhstan is the only non-Baltic CIS country to have developed a viable banking system. Although the market is still fragmented, the top banks have all been growing rapidly on the back of successful economic development.
Kazakhstan gained investment-grade status from Moody’s during the course of the year and this has encouraged a number of banks to issue Eurobonds. Only the top few banks are rated at investment grade, mainly as a result of the high likelihood of government support, but all Kazakhstan’s banks benefit from the higher international standing of the country. And although there is no tangible reason to think that asset quality will falter as the banks’ loan portfolios mature, future success is closely linked to continuing growth in the economy.
Despite all the regional tensions in this past year, most banks in the Middle East performed well in economies buoyed up by high oil prices. Their bottom lines, as always, are helped by benign tax regimes. Growth has come mainly from increases in consumer lending, and in some cases this has reached worryingly high multiples of salary that could lead to repayment problems if the environment becomes more challenging. Also, as this business is relatively new, banks are still refining their scoring systems and it could be that asset quality is adversely affected in the next few years.
Banks on the front line
Banks in the two countries most directly affected by the intifada – Israel and Jordan – performed as expected. The slowing Israeli economy, with construction, high-technology industry and tourism all badly affected, led to lower profits and even losses at the major banks. However, balance sheets remain relatively strong, though banks will be hoping that recent moves to reduce local tensions can be sustained. Although the Jordanian economy has held up remarkably well, the leading banks all have significant exposures in Palestine where it has become almost impossible to sustain viable banking operations.
Public-sector banks in Egypt are finally being restructured. The early experiment at Banque du Caire, where bankers with western experience were brought in to bring a new professionalism to operations and resolve past problems, is being repeated at the other three large institutions.
Experience at Banque du Caire suggests that it will not be rapid change, but the government has given new managements three years to solve the problems. Although this could be an overly optimistic time-scale, there is an enthusiasm for change that could bring results. In the interim, minimal growth and pressure on profits is to be expected at these banks and this could mean that the leading private-sector names are set to benefit.
The biggest problems in the region were seen in the Bahraini offshore sector, where the leading banks were hit by the poor performance of the global capital markets and by the near collapse of the private-equity market. Some banks also had exposure to one or more of the big corporate failures in the US and Europe, exposures that have damaged balance sheets more here than in developed markets because of the relative size of the facilities.
Two smaller banks no longer included in our list, Bahrain International Bank and BMB Investment Bank, are fighting for survival and need to persuade their medium-term lenders to take losses and restructure facilities.
South African consolidation
The one African country to feature significantly in the emerging market banks listing is South Africa. This market benefits from the presence of a number of strong players with domestic, regional and international operations. In 2002 these banks gained from the demise of the second-tier banks following a liquidity and confidence crisis. The four large commercial banks now dominate the market but still face the challenge of developing services for the majority of the population that remains outside the formal banking sector.
This is being pursued by the adoption of a “financial empowerment charter” that will require banks to include black South Africans among their shareholders, directors, top management, employees, suppliers and customers. This presents a huge challenge, but also a major opportunity for those that adopt a successful strategy.
