Panayotis Thomopoulos: The financial environment in Southeast Europe
Speech by Mr Panayotis Thomopoulos, Deputy Governor of the Bank of Greece, at the Second
International Banking Forum for the Southeast European Markets Economist Conference, Athens,
4 December 2003.
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It is a great pleasure to address this Banking Forum at this juncture as I believe that the economies
are turning the corner and can now start enjoying the benefits of stability and growth within the
framework of closer ties with the European Union. After a difficult and hesitant start in the 1990s, there
is now clear evidence that the transition economies of Southeastern Europe have improved their
macroeconomic management and enhanced their financial systems so that they can look forward to
sustained and high-quality growth.
Greece, as the only member of the European Union in the region, has a clear interest in promoting the
stability and growth of all our neighbors, and I can be proud that both the public and the private
sectors of Greece have played a role in the emerging success story of Southeastern Europe. We see
our neighbors' economies mainly as complementary to our own, not as competitors, and the many
Greek businesses that are active in the region, especially in the financial sector, are proof of the
increasing collaboration between my country and its neighbors. I believe that Greece will continue to
make a positive contribution to the economies of the region, but, I must admit, that I draw comfort from
the fact that Greece is now surrounded by open, dynamic economies, and I would add friendly
countries. It would be an understatement to say that we have turned a page of our history. In effect,
the collapse of communism ended not the thirty, or hundred years wars, but more than one thousand
years of intrabalkan conflicts and Greece is fully supporting Balkan countries' E.U. membership, which
would further strengthen the political and economic ties between all Balkan countries.
Let me start with a short look at the international environment that the countries in Southeastern
Europe are facing. The overall economic situation has improved significantly during the last few
months. After months when expectations of a recovery were based mostly on so-called "soft data," like
surveys of consumer and business confidence, we are now seeing real "hard data" that point to the
resumption of growth in all the main regions of the world economy. All members of the EU have now
emerged from recession, although the growth rate is not what we would have wished it to be. Growth
in the eurozone should accelerate slowly, and within the next year the growth rate should gradually
approach its potential, estimated at around 2 ? % per annum. The US, on the other hand, is growing
fast, maybe too fast. Certainly, I do not wish to belittle the achievements of the American economy,
especially its high productivity growth, but the continuation of the twin deficits are certainly a cause for
concern, in that a sudden correction could have far-reaching implications for the international financial
system. The US sees with benign neglect its twin deficits. On the one hand, it expects that continuing
fast rate of growth would generate sufficient tax revenues over the medium term, which, in
combination with the gradual phasing out of some tax relief measures, will reduce the deficit and, on
the other hand, they expect the current balanced of payments correction to be realized via a
devaluation of the US dollar, which would help the sustainability of the US recovery and generate
higher profits in dollar terms from the US investments abroad. In summary, they don't expect an abrupt
and substantial rise in interest rates, which would have had adverse effects both on the fiscal deficit
and on consumer demand, thus precipitating a cyclical downturn. However, the European point of
view, if I am allowed to summarize, is that an unsustainably fast growth rate, based on private and
public borrowing is not good for anyone and the US cannot be an exception.
The EU, and especially the eurozone, has played a constructive role in promoting a stable financial
environment. The recent appreciation of the euro is an indication of the markets' confidence in our
economies. I believe that a strong euro is good for Europe and the world, as it helps fight inflationary
pressures and supports the confidence of consumers and producers. It is also clear that the eurozone
cannot solve all the imbalances that threaten the stability of the international economy. I do not wish to
enter the debate on whether the fiscal stimulus in the US was necessary two years ago, at the onset of
the economic slowdown, but certainly it has to be reversed now as the US is growing at an
unsustainable rate. At the same time, third countries, especially those in Asia, should contribute
themselves by allowing market forces to play a greater role in the determination of their exchange rate,
and by abandoning their mercantilistic attitudes. However I should mention that, there is an open
debate whether a revaluation of the chinese renminbi is at present appropriate, given, on the one
hand, the fact that it will make relatively small difference, as far as it concerns China's trade surplus, if
the chinese wage expressed in US dollars from about 10% of the US or EU average wage rises to
15% or 20% as a result of the revaluation, and on the other hand, a revaluation could lead to a
deterioration of the already Chinese banks' fragile conditions and would also make more expensive
the acquisitions of Chinese factories, commercial sites, etc by foreign investors.
One positive development that I cannot stress enough is the absence of any challenges to the
financial stability in Europe and the US. Unlike the situation in the early 1990s, we have recently gone
through a period of a prolonged and synchronized slowdown, made worse by geopolitical risks, with
no major financial institution being impaired. There have been of course problems, especially in the
European insurance sector, exacerbated by natural catastrophes, but all financial institutions have
managed through. Undoubtedly, those who make mistakes, or are simply unfortunate, suffer in a
market economy. Nonetheless, such problems, whenever they surfaced, were contained and did not
have systemic repercussions that could threaten the macroeconomic stability of our economies.
Indeed, in our E.U. economies we have long recognized the key role of the banking sector and its
health has been a constant preoccupation of the authorities, especially of Central banks which, even
those not directly involved in supervision, have a wider responsibility for the good functioning of the
financial system as a whole and the payment systems. We have been building sound banks, which not
only can withstand successfully cyclical pressures and other kinds of shocks, but also they bring
crucial support to the economy when failures appear in other, less important, parts of the financial
system. The bursting of the stock exchange bubbles and the subsequent substantial decline in their
capitalization, in certain countries amounting to as much as 30 to 50% of GDP, produced relatively
little damage and which was, moreover, contained thanks to the banking sector. Likewise, as a result
also of what I would say, the least, "not very prudent policies" the significant losses of insurance and
re-insurance companies in the last few years have been partly absorbed by the banking sector, which
responded promptly to their needs for liquidity and capital injections. The banking sector in some
countries has unwillingly assumed the responsibility for the well being of the financial sector as a
whole, because it understands the danger of systemic risks, that can wreak havoc.
I cannot pretend that there were not tensions here and there, or losses due to the write-offs of
nonperforming loans, to plummeting share values and to laying off costs, but only a few banks posted
operating losses and, moreover, those, as a rule, were relatively small. Even today, after three years
of a downturn, the capital adequacy ratio, has remained well above the minimum 8% in almost all
cases, and for the E.U. as a whole the average is above 10%, which underlines the good health of the
banking system. Moreover, it is expected that it will continue to improve as the recovery gets
underway.
Here, I wish to repeat the very positive role of Central banks, which, almost all were over more than 50
years, and many of them still are the supervisory authorities. Indeed, central banks succeeded in
creating a competitive and sound banking system in Europe during the last fifteen years or so, during
a period characterized by liberalization in financial markets and intense competition both within Europe
and from the US banks. The lesson I draw is that with the help of their natural interlocutor, the central
banks, the private sector has become more adept in dealing with risks and the supervisors have
learned from the mistakes of the past and improved their vigilance. Looking ahead, the new prudential
practices to be introduced under Basel II will further improve our ability to deal with financial risks and
better tailor our prudential requirements to each market's special needs.
Another positive development is the diminishing danger of contagion, as we have seen after
Argentina's default, which did not lead to widespread withdrawal of funds from emerging markets. This
is particularly significant for the emerging market economies in Southeastern Europe, which look to a
greater integration in the world economy without the fear of being hit by a crisis that originates
elsewhere. All this of course, provided they maintain healthy fundamentals.
Turning now to the developments in the Southeastern Balkans themselves, the present situation is a
far cry from the bleak picture at the early stages of transition, more than a decade ago. Apart from
often-bloody conflicts, hyperinflation and financial stability seemed endemic in the region only a few
years ago. Regarding the financial sector, starting from an initial position with practically no
commercial banks, the countries in the region faced problems that were often beyond their
administrative and regulatory capabilities. Financial institutions were reformed with insufficient
regulation and unclear focus and expansion was associated with improprieties, scandals and
fraudulent schemes during the early stages of transition. Therefore, the financial sector was unable to
attract deposits and develop extensive client networks. Finally, state banks were compelled to carry a
high number of non-performing loans, which had been accumulated by the government subsidization
programs to state run enterprises.
The development of the financial sector was hampered at the beginning by inadequate
macroeconomic management. Fiscal deficits were mostly excessive, and often monetized, and the
inevitable outcome was high inflation. It is encouraging that in the last few years we can see clear
evidence of maturity in economic management.
The path to macroeconomic stabilization was different for every country. In the region we can now
observe all types of monetary and exchange rate regimes, from formal euro-ization and currency
boards linked to the euro, all the way to monetary targeting. This is proof, if proof was needed, that
there is no single solution, to economic problems but that the policies of each country should be
tailored to its specific needs. Going beyond the diversity of the region, at this point I would like to
underline two characteristics of the financial system of practically all countries in the region, which are
the result of their past, but will also shape their future developments.
The first is extensive currency substitution. As a result of past inflation, but also because of the large
numbers of people working abroad, foreign currencies, and especially the euro, play a large role and
they have often become the main currency in use. One can gauge the degree of currency substitution
by noting that in all countries in the region deposits in a foreign currency account for at least half of all
bank deposits. One must add to this, money "kept under the mattress" and capital flight. Undoubtedly
all these were a vote of no confidence in domestic policymakers. People showed their dissatisfaction
with local financial institutions and monetary authorities by moving their savings abroad, or by using
other, more stable currencies. This high degree of currency substitution can only be found in some
Latin American countries and undermined the effectiveness of monetary policy. The ability of monetary
authorities to extract seignorage was severely limited, and this is a partial justification of the high
inflation rates. At the same time, monetary management became more difficult, as small shocks had a
disproportionately big impact on inflation and the exchange rate.
In some countries, namely Bulgaria, the extent of hyperinflation and currency substitution left little
alternative to the authorities but to accept the reality and move to a hard peg in the form of a currency
board linked initially to the Deutschemark and now to the euro. Similar regimes were also imposed on
Bosnia, after the Dayton Accord, and Kosovo. The euro is an appropriate anchor for an
exchangerate-based policy in these countries, as they are closely integrated with the countries of the eurozone.
Most of their transactions, not only trade-related, but also workers' remittances, official transfers and
financial transactions are with countries of the eurozone.
A measure of macroeconomic success is the receding level of currency substitution. In 2002, the last
year for which we have full data, bank deposits in foreign currencies fell as a proportion of total
deposits in all countries in the region, sometimes quite fast in countries with strong performance in the
context of monetary or inflation targeting, with only one exception. This is indicative of a growing trust
in the domestic currency and the effectiveness of stabilization. It is all the more important that this
achievement should not be squandered, and that prudent macroeconomic policies should continue.
Nonetheless, I would like to warn of possible problems, especially in those countries that have tied
their exchange rate to the euro, one way or another. The weakness of the euro until last year
undoubtedly helped both their growth performance and their external competitiveness. From now, in a
period of strong euro they will have to rely more on domestic productivity gains and structural
adjustments to maintain their growth rates. In addition, and as growth takes hold in advanced
economies, countries in the region will have to adjust to interest rates higher than their current
historically low levels.
An area where much remains to be done is the area of developing an efficient and stable financial
system. In this respect, the economies in the region lag behind the other transition economies that are
due to join the EU next year. The public sector still controls a substantial part of the banking system,
and there is an obvious need to continue the efforts to privatize the remaining state-controlled banks.
As in most transition economies, state interference has not been a stabilizing factor, quite the
opposite. State controlled banks have often lost substantial sums in politically-motivated investments
and have contributed to systemic crises in all those countries.
As in other transition economies, we can foresee that an increasing number of banks will been taken
over or become affiliated with foreign ones. Setting aside nationalistic prejudices, I think this should be
seen as a welcome development as a whole, provided the foreign entrants are strong and
wellsupervised financial institutions. In the acceding countries of Central Europe foreign banks already
play a major role after the crises that hit those countries in the late 1990s, and the overall experience
has been positive. (Foreign banks control more than 80% of the domestic market in a few central
european acceding countries).
Foreign banks bring with them many advantages, especially in the case of countries with a limited
experience with sophisticated financial markets. At first, they have access to better know-how and
technology. More importantly, they are mostly immune from political interference. While local
participants are often intimidated or pressured to give loans to well-connected borrowers, foreign
institutions generally feel stronger to resist such pressures. Also, foreign banks are considered "safer"
by local depositors, who recognize that they are not manipulated by the political authorities, and who
also understand that foreign banks are supervised by the more experienced supervisors at home.
Finally, experience with other emerging markets shows that foreign banks are better able to withstand
losses in cases something goes wrong. The international evidence shows that banks affiliated with
ones from advanced economies have access to capital at lower cost than local ones and can be
recapitalized faster and more easily than the others.
Of course, foreign banks may have its disadvantages. Foreign-owned financial institutions may lack
understanding of how the local market works. Indeed, it has been noted that such banks often tend to
concentrate on financing affiliates of foreign firms, or only large local firms. There is thus a danger that
local small and medium enterprises may find their access to credit curtailed. There is also the
possibility that foreign-owned banks will alter their credit based not on the local conditions, but on the
conditions in their home economies.
Indeed, in Greece we have observed that foreign banks have entered the market and subsequently
they expanded or left in a haphazard way, not on the basis of local conditions or profitability, but
mostly on the basis of wider strategies whether to expand globally or not. Formally, we can say that
this increases the correlation of emerging markets with the outside world. Research shows that the
operations of financial multinationals are becoming a major channel for the transmission of business
cycles. For that reason, economies in the Southeastern Europe will find that their economies are more
and more affected by what is happening in the rest of Europe than with what is happening locally.
Although at times of local euphoria you may regret being held back by the European business cycle,
over time the benefits of becoming tied to the more stable economy of the eurozone will become
overwhelming. This is especially so for countries that are applying for EU membership. Greater
synchronization with the European cycle will smooth their path towards full membership. Foreign
ownership of banks will also allow a greater risk diversification than what might be achievable by small
local banks whose whole portfolio is locally invested. Foreign banks can thus behave in a less
riskaverse way than local ones.
The issue of financial stability and proper supervision is very important for us, at the Bank of Greece,
as Greek firms have invested heavily in our neighboring countries. In most of them Greece is among
the five biggest suppliers of foreign direct investment. Of course, this has to some extent caused
delocation of greek companies, with a negative impact on investment and employment in Greece over
the short to medium-term, but for an economy growing at almost 4% p.a. since 1997 and with an
investment GDP ratio of 24% delocation does not pose a serious threat to its long term performance.
Looking at the data in preparation for this speech, I was amazed by the number of branches of Greek
banks in our neighboring countries. This shows that Greek banks have entered planning to offer a
wide range of services and they see their future closely linked to the evolution of the host economies.
They are not entering in order to concentrate in just a few lucrative activities and offer services to other
Greek firms.
The positive effects of the presence of foreign banks predicted by theory are supported by the
experience of Greek banks in the countries of Southeastern Europe. Greek banks are already
wellestablished in Bulgaria, Romania, Serbia-Montenegro, Albania and FYROM, representing at least 20
percent of the banking system according to assets and in some of them their share is between
onethird and two thirds. Overall, they are better capitalized than their competitors, something that could be
expected as they have access to a more diversified source of funds. Their better capitalization allows
them to take somewhat higher risks, as shown by the fact their loans to the private sector are
generally a higher share of their assets than for the average bank. Although they take somewhat more
risk, they are profitable overall, more than their average competitors. This signifies that Greek banks in
the region have some comparative advantage, either in the form of access to capital markets, or
because of superior organization and know-how, and good understanding of local conditions.
While Greek banks play a major role in the neighboring economies, their exposure to these economies
is generally small. For no Greek banks does the exposure to Southeastern Europe exceed 3 percent.
This is simply a reflection of the different levels of development in Greece and nearby countries. The
result is that while Greek banks face little risks from their exposure to these economies, they
themselves are important for the stability of the financial system in the Balkans. In the Bank of Greece
we are well aware of this, and we take our responsibilities to our neighbors very seriously indeed. As
home country supervisors we recognize that our ability to exert prudential supervision has effects
beyond Greek borders.
In recent years we have signed several agreements, in the form of memoranda of understanding, and
we are discussing some further ones with other supervisors in the region in order to enhance our
ability to ensure the stability of the banks under our jurisdiction. What is needed, beyond formal
agreements, is the confidential and frank exchange of all information among supervisors in order to
identify problems early on, before they become threatening. In this era, we should also be vigilant to
avoid abuses of the financial system for illegal activities, such as money laundering and terrorism
financing.
Of course, we take comfort from the fact that the Greek banks that have expanded in the Balkans are
quite strong, well above the necessary prudential ratios. Actually, the fact that Greek banks have been
able to retain a very high share of their local market is also an indication that they have some
comparative advantages that allow them to thrive in an internationally competitive environment.
I must admit that our interest in the stability and growth of our neighbors is to some extent a reflection
of selfish instincts. We realize that strong and growing economies in this region are not only useful for
the Greek economy, but also a prerequisite for the political stability of the Balkans. I mentioned before
that the presence of foreign financial firms in the Southeastern Europe would transform their business
cycles. But it works the other way round. Greece's orientation toward the dynamic economies in our
region has helped us somewhat weather better than most the recent economic slowdown. In a very
specific way, one can see the growing interlinkages in the Balkans as evidence of how trade in goods
and financial services can help growth and stability.
Looking ahead, the challenges for our neighbors remain formidable. Now that the first steps towards
stabilization and growth have been taken, what lies ahead is the more difficult issues of managing an
emerging economy. Top of their priorities I would like to put the improvement of their governance
structures, the further deregulation and privatization and the strengthening of the respect for property
rights. I should end by saying that they can count on our continued support.