Lithuania, Hungary, and Georgia, and is just below 10 for Albania and Latvia. Thus, assuming that all the assets of Ukrainian banks are loans these banks would require more than 30 years of pre-crisis profits to cover the loan losses incurred during the crisis. By contrast banks in Estonia or Turkey could cover the increase in NPL during the crisis with 1 year of pre-crisis profits.

The analysis above suggests that banks in several transition countries are likely to struggle with the high NPL ratios they have accumulated during the crisis and the possible losses associated with such loans. One consequence might be a contraction in lending and the question that arises is whether firms or households would be more affected. To assess this, we take data on the share of private credit extended to firms and households from the EBRD transition report. On average across our sample of countries the share of private credit extended to firms is 58% (mean 2007-2009), ranging from 44% in Croatia to 76% in Slovenia. The share to households is thus on average 42% in our sample. We plot the severity of the NPL problem (change in NPL ratio / pre-crisis ROA) by country against the share of loans made to firms (Figure 4.3.b) or households (Figure 4.3.c) respectively.

Figures 4.3.b and 4.3.c show that the countries with the most severe NPL problems (Ukraine, Lithuania, Hungary, and Georgia) all have structures of lending that correspond to the sample average. In all of these countries the share of lending to firms is roughly 60%, while that to households is roughly 40%. This indicates that debt overhang in the banking sector of these countries is likely to affect both sectors, with firms slightly more affected than households.

# <u>Foreign Banks during the Crisis</u>

Political as well as financial integration with Western Europe including a major presence of multinational banking groups had been the predominant model of development in most of the transition region since the mid-1990s. This model of cross-border finance had stimulated longterm growth (EBRD (2009)) and attenuated the effects of host country crises as foreign greenfield banks had kept their lending stable whereas domestic banks had been found to decrease lending (De Haas and Van Lelyveld (2006)). Thus, the availability of funds from internal capital markets made foreign banks in the transition region more resilient to host country crisis. However, the very same linkages included the risk of the transmission of a crisis from these banks‟ home countries to emerging Europe. Apart from that, foreign banks had been the drivers of an enormous credit boom including many foreign currency loans to often unhedged borrowers (EBRD (2010)). So how did foreign banks react to the 2007-2009 crisis? Did multinational banking groups contract their lending in the transition region because of financial problems at their parent banks thereby reinforcing the real effects of the crisis?

The empirical evidence so far is mixed. Popov and Udell (2010) find that the financial distress at foreign parent banks was indeed transmitted cross-border to emerging Europe leading to a reduction in lending to firms during the early stage of the crisis in 2007-2008. Their data on firms come from the 2009 wave of BEEPS (see section 4.1. for details). They match this data with information on bank presence in the localities of firms and bank balance sheet data from Bankscope. Although their dataset does not allow them to directly match firms with their banks, they can provide evidence that firms in localities served by foreign banks whose parents experienced financial distress have a higher probability to be credit constrained. Explicitly controlling for demand shifts and selection of firms out of the application process, they also find 37