SUMMARY
Based on survey data from 193 banks in 20 countries we provide the first
bank-level analysis of the relationship between bank ownership, bank funding
and foreign currency (FX) lending across emerging Europe. Our results contra-
dict the widespread view that foreign banks have been driving FX lending to
retail clients as a result of easier access to foreign wholesale funding. Our
cross-sectional analysis shows that foreign banks do lend more in FX to
corporate clients but not to households. Moreover, we find no evidence that
wholesale funding had a strong causal effect on FX lending for either foreign or
domestic banks. Panel estimations show that the foreign acquisition of a domes-
tic bank does lead to faster growth in FX lending to households. However, this
is driven by faster growth in household lending in general not by a shift
towards FX lending.
— Martin Brown and Ralph De Haas
Foreign
banks
in
emerging Europe
Economic Policy January 2012 Printed in Great Britain
Ó CEPR, CES, MSH, 2012.
Foreign banks and foreign
currency lending in emerging
Europe
Martin Brown and Ralph De Haas
University of St Gallen; European Bank for Reconstruction and Development
1. INTRODUCTION
Unhedged foreign currency (FX) borrowing is seen as a major threat to financial sta-
bility in emerging Europe. More than 80% of all private sector loans in Belarus, Lat-
via and Serbia are currently denominated in (or linked to) a foreign currency and
the share of FX loans also exceeds that of domestic currency loans in various other
countries including Bulgaria, Hungary and Romania (European Bank for Recon-
struction and Development (EBRD), 2010. FX borrowing throughout the region is
dominated by retail loans – household mortgages, consumer credit and small busi-
ness loans – to clients which typically have their income and assets in local currency.
It is therefore not surprising that national authorities have taken measures to dis-
This paper was presented at the 53rd Panel Meeting of Economic Policy in Budapest. We would like to thank Asel Isakova
and Veronika Zavacka for helpful statistical assistance and La
´
szlo
´
Halpern, Olena Havrylchyk, Maria Soledad Martinez Pe-
ria, Alexander Popov, Marta Serra Garcia, Karolin Kirschenmann, Ce
´
dric Tille, Aaron Tornell, Paul Wachtel, Frank West-
ermann, Jeromin Zettelmeyer, three anonymous referees, and participants at the EBRD Research Seminar, the XIX
International Tor Vergata Conference on Money, Banking and Finance, the EBRD-Reinventing Bretton Woods Committee
Conference on Developing Local Currency Finance, and the 53rd Economic Policy Panel Meeting for useful comments. The
views expressed are those of the authors and do not necessarily reflect those of the EBRD.
The Managing Editor in charge of this paper was Philip Lane.
FOREIGN BANKS IN EMERGING EUROPE 59
Economic Policy January 2012. pp. 57–98 Printed in Great Britain
Ó CEPR, CES, MSH, 2012.
courage such loans. Supervisors in Hungary, Latvia and Poland have pushed banks
to disclose the exchange rate risks of FX loans to clients and to tighten the eligibility
criteria for such loans. In countries like Croatia, Kazakhstan and Romania stronger
provisioning requirements were imposed on FX compared to local currency loans.
Ukraine even completely banned FX lending to households in late 2008.
The call for policies to curb FX lending in Eastern Europe has intensified lately.
In June 2010 the European Central Bank (ECB) stated that national efforts to rein
in FX lending have had little impact and called for better coordination, including
among home-country regulators of banks with subsidiaries in Eastern Europe.
1
In
this line of thinking FX lending is largely supply-driven, with FX funding of banks,
often from their parent banks, at the heart of the problem. Surprisingly, the wide-
spread view that FX lending in Eastern Europe is driven by foreign bank subsidiaries
with access to ample FX funding has not yet been substantiated by empirical ana-
lysis. Comparisons of cross-country data document higher shares of FX lending in
countries where banks have larger cross-border liabilities (Bakker and Gulde, 2010;
Basso et al ., 2010). However, whether such liabilities are causing or being caused by
FX loans is hard to establish from aggregate data. Recent loan-level evidence for
Bulgaria suggests that FX lending seems to be at least partly driven by customer
deposits in FX, while wholesale funding in FX is a result rather than a cause of FX
lending (Brown et al., 2010). It is unclear, however, whether this applies to a broad
set of banks across the transition region.
The impact of foreign bank ownership on euroization and financial stability is a
pertinent policy question. After the fall of the Berlin wall governments and develop-
ment institutions actively supported the process of banking integration between
Western and Eastern Europe. This support was based on the presumed positive
impact of foreign bank entry on the efficiency and stability of local banking systems.
The empirical evidence that emerged over the next two decades suggests that for-
eign banks indeed contributed to more efficient (Fries and Taci, 2005) and stable
(De Haas and Van Lelyveld, 2006) banking sectors. However, the recent financial
crisis has hit emerging Europe hard and questions have been raised about foreign
banks’ role in creating the economic imbalances, including large unhedged FX
exposures, which made the region vulnerable. Regulation may help to counterbal-
ance distortions – such as banks and borrowers that disregard the negative external-
ities of FX loans in terms of increasing the risk of a systemic crisis (see Rancie
`
re
et al., 2010). Our paper contributes to this debate by using bank-level data to
analyse to what extent FX lending in Eastern Europe is related to the presence of
foreign banks and their funding.
Our main data source is the EBRD Banking Environment and Performance
Survey (BEPS) conducted in 2005 and covering 95 foreign-owned and 98
1
http://www.ecb.int/pub/pdf/other/financialstabilityreview201006en.pdf.
60 MARTIN BROWN AND RALPH DE HAAS
domestic-owned banks in 20 transition countries. The BEPS elicits detailed informa-
tion on the loan and deposit structure of each bank in 2001 and 2004, its risk man-
agement, as well as its assessment of local creditor rights and banking regulation.
We match the BEPS data with financial statement data provided by Bureau van
Dijk’s BankScope database and with country-level indicators of the interest rate dif-
ferential on foreign versus local currency funds, exchange rate volatility, inflation
history, and the position of the country on the path towards EU accession.
While we do not cover the immediate run-up to and aftermath of the recent
financial crisis, the observation period covered by our data is particularly interest-
ing to study FX lending dynamics. During this period foreign currency lending
to corporate clients was already widespread in Eastern Europe. For the banks in
our sample the mean share of the corporate loan portfolio denominated in FX
was 41% in 2001 and 44% in 2004. During this three-year period we do, how-
ever, observe a significant increase in FX lending by banks in some countries
(such as Belarus and Estonia) while in other countries (Kazakhstan, Russia) banks
reduced FX lending. Furthermore, FX lending to households increased substan-
tially across Eastern Europe during our observation period. Considering the
banks in our sample, we find that the share of FX loans in their household loan
portfolio increased from 28% in 2001 to 38% in 2004. Our data allow us to
investigate to what extent these developments in FX lending to corporate and
household clients are related to changes in the ownership and funding structure
of banks.
Our results contradict the view that foreign banks have been driving FX lending
to unsuspecting retail clients throughout Eastern Europe as a result of easier access
to cross-border funding. First, our cross-sectional results suggest that while foreign
banks do lend more in FX to corporate clients, they do not do so to households.
Second, while the foreign acquisition of a bank does lead to faster growth in FX
lending to retail clients, this is driven by faster growth in household lending per se
and not by a redirecting of credit from domestic to foreign currency. Third, we find
no evidence that wholesale funding had a strong causal effect on FX lending for
any type of bank over the 2001–2004 period. The correlation between wholesale
funding and FX lending at the bank level is weak. If anything, wholesale funding
seems to be a result rather than a determinant of FX lending.
All in all, our findings tell us that foreign banks did not indiscriminately ‘push’
FX loans through their subsidiary network in the transition region, but followed a
more subtle approach where FX lending is targeted to (corporate) clients that can
carry the associated risks and to countries in which FX lending to households is
attractive from a macroeconomic perspective. These results provide important
insights to policymakers into the drivers of FX lending. In particular, they suggest
that credible macroeconomic policies which encourage depositors to save in local
currency may be more important than regulatory proposals to limit the wholesale
funding of banks.
FOREIGN BANKS IN EMERGING EUROPE 61
