Financial FDI in CEECs revisited – in
the context of the dependent
market economies model
Zoltán Gál and Magdolna Sass
Centre for Economic and Regional
Studies of HAS,
Budapest, Hungary
RSA Research Network on Geographies of Finance and PostSocialist Transformations , Bratislava workshop,
16-17 of May, 2013
Outline
• Work-in-progress
• Research question
• Theoretical background/review of the
literature on the topic
• Method
• Data and facts – NMS and Visegrad+Slovenia
• Main findings
• Conclusion
Research question
• The role of FDI in financial services in posttransition economies (Visegrad+Slovenia): the
impact of foreign ownership during the crisis
years in terms of financial stability
• Hypothesis of a dual financial/banking system
evolving in the DME (VoC)context and its
impact during the crisis years
New variety of Capitalism: Dependent
Market Economy (DME) model
• DME is created an unequal power relation between the home
countries and CEECs through parent-subsidiary networks of TNCs
(Raviv, 2008., Nölke and Vliegenthart, 2009, Myant and Drahokoupil,
2010).
• Foreign credit institutions were never geared towards addressing the
developmental needs of the host CEE economies (Raviv, 2008).
• Foreign financiers emerged as a powerful rentier class in Central
Europe able to extract rent incomes far in excess of their profits in
the west.
• Unprecedented transfer of property rights from local society to
foreign investors, but also to increased unsustainable indebtedness
and risk.
• TNCs prefer to hierarchically control local subsidiaries from their
headquarters as an alternative mode of finance and governance
rather than to accept financing by international capital markets and
outsider control by dispersed shareholders (LME), or to accept
financing by domestic bank lending and insider control (CME) (Nölke
and Vliegenthart 2009)
Theories on Financial system (re)integration of
CEE revisited
Reintegration & Transition theory: Banking in Transitions Economies,
developing market Oriented Banking Sectors in Eastern Europe.
(Bonin et al. 1998)
–
–
How does foreign entry affect domestic money markets? Why do banks
establish foreign subsidiaries? (Claessens et al. 2001, Buch, 2003, Berger et al.
2004)
Entry EU banks and FDI in banking (brownfiled & greenfield privatization
(Wachtel 1998)
Modernization theory: Supporting bank privatization by foreign
strategic investors vs. state ownership; key role of foreign banks in
institutional development, stability and the increase of financial
depth (Várhegyi 1993, Király 2005, Csaba, 2011)
Impact of foreign bank (FP)presence on financial stability during the
crisis: negatively related to domestic credit creation during the crisis
and foreign banks reduced lending more than domestic banks in
avarage (esp.developing countries), except when they dominated the
host banking system (Claessens and van Horen 2012).
-If FB generated majority of their funding from local deposits were
less much likely to reduce lending.
5
Theories on Financial system (re)integration
of CEE revisited
• Unequal parent–subsidiary relations
– Concentration of controlling functions over CEE within the
international financial centres (IFC), (Kareman 2008, Wójcik, 2007,
Gál, 2010a,b).
– the hierarchy between TNC headquarters and local subsidiaries
replaces markets (LME) and associations (CME) as a typical
coordination mechanism within these economies.
• Emerging dual banking system and its implication for spatial
polarization and uneven development (Alessandrini & Zazzaro, 2009,
Gál, 2005)
• Local banking structures are missing or weak, the strong
dependence on the foreign banks
• The concentration of large banks with foreign ownership and
the weakness of locally founded, smaller indigenous banks
(e.g. cooperative savings banks),
Method and facts and data on V4
and Slovenia
• We use various indicators of the financial
services/banking sectors of CEE/V4+Slovenia
• Comparing pre-crisis and post-crisis (?) period
SHARE OF FOREIGN OWNERSHIP IN THREE STRATEGIC SECTORS, 2007
Country
Czech Republic
Hungary
Poland
Slovak Republic
Automotive
93.1
93.2
90.8
97.3
Manufacturing
52.6
60.3
45.2
68.5
Electronics
74.8
92.2
70.3
79.0
Banking
85.8
90.7
70.9
95.6
Financial reintegration of CEE
• Shift ownership from
– PUBLIC to PRIVATE
– DOMESTIC to FOREIGN
PRIVATIZATION = FOREIGNIZATION
• FDI became the predominant type of inward investment in
the first stage of transition (privatization, country
differences)
• Primary target of FDI: banking&Insurance (bank based
finance)
• Foreign Banks (understandably) followed commercial
principles rather than economic development
Pre-crisis: Market share of foreign-owned banks in total
banking assets 2006 (%)
Source: Local Central Banks, EBRD Transition Report 2006 ‘Finance in Transition’.
Pre-crisis: Foreign ownership
Domination of foreign banks as a financial intermediaries
Foreign banks control the majority of assets (mainly West European), and
penetrated very early in retail segment
SHARES OF FOREIGN BANKS: 20% in OECD; 50% outside OECD
Post-crisis: Foreign shares
in international
comparison
- Relatively large (compared e.g.
to the level of economnic
development)
• FDI flew into the banking
sectors: unprecedented shares
of foreign ownership
– Developmental needs of CEE
(pull )
– Market pressures for foreign
banks (push)
- Similarly to global processes:
foreign bank entry is regionally
concentrated, main investors:
banks from traditional/strong
economic and trading partner
countries, i.e. mainly eurzone
countries for CEE
- However, trend for intraregional banking integration
(main player: the Hungarian
OTP)
OTP Group is the only local player in CEE
region, with 100% of group assets in the region
DATA AS OF
2008
UniCredit
53%
Raiffeisen
2051%
Erste
157%
KBC
112%
(5)
Total Assets(1)
EUR bn
Net Profit(2)
EUR mn
121.6
2,577
85.4
79.3
(4)
1,078
Number of
Branches
Countries of
presence(3)
4,005
19
3,231
1,569
2,099
71.6
309
1,940
65.9
1,201
SocGen
41%
IntesaSP
5%
42.5
186
1,781
OTP
n.s.
35.2
958
1,573
CEE, % share in
Group Assets
12
16
54
7
39
12
2,609
20
16
11
9
6
7
100
..% Contribution of CEE in Group Net Profit (After tax, after minority interests)
Notes: (1) 100% of total assets, and profit after tax (before minority interests) for controlled companies (stake > 50%) and pro rata for non- controlled companies (stake < 50%).
(2) After tax, before minority interest. (3) Including direct and indirect presence in the 25 CEE countries, excluding representative offices. (4) KBC Group recorded a loss in 2008.
(5) SocGen including ProFin Bank in Ukraine.
Source: UniCredit Group CEE Strategic Analysis
12
Post (?)-crisis: FDI in financial services
in NMS, 2010 (source: WIIW)
Crisis years + post-crisis: FDI in financial
services, Visegrad+Slovenia
(million euros, 2006-11, source: national banks)
Post-crisis: Foreign shares…
Share of foreign-controlled companies in
the gross value-added of Financial
services (CZ, HU)
Source: statistical offices, national accounts
Sources of Finance in DME model
Country
Stock Market
Capitalization
(Percentage of GDP)
Domestic Credit to
Private Sector
Inward FDI stock
RATIO INWARD
FDI
STOCK/OUTWAR
D FDI
(Percentage of GDP) (Percentage of GDP)
DME (DEPENDENT MARKET ECONOMIES)
Czech Republic
Hungary
Poland
Slovak Republic
31.0
29.5
30.1
25.0
33
46
28
31
48.0
51.8
24.9
31.5
15.3
6.4
9.7
23.6
LME (LIBERAL MARKET ECONOMIES)
U.K.
U.S.
138.9
136.9
156
249
37.8
12.7
0.8
CME (COORDINATED MARKET ECONOMIES)
Austria
Germany
41.3
43.7
106
112
22.7
16.4
1.0
0.5
Implications for unequal parent-subsidiary
relations: transnational network connectivity
• SHIFT in key decision making/control functions to the parent banks
(outcome of previous FDI)
• Reduce the information available for host country supervisors
• Power relations: CEE centres is subordinated by West European IFCs
• Connectivity through parent-subsidiary network
– Concentration of outdegree connections (sender IFCs) forms
Western gateways to CEE (Vienna, Paris, Athens, Frankfurt)
– Concentration of indegree connections (hosting hubs)forms
bridgehead centres in CEE (Moscow, Warsaw, Budapest)
• Lack of control function in IFCs located in CEE capital cities
– Only exception is Budapest: control functions of OTP Bank (OTP is
the only regionally based MNC with regional subsidiaries network)
17
Parent (HQ)-subsidiary (CEE) relations
-- degrees of financial connectivities
Kareman,2008, Gál, 2010
18
Concentration of control functions of parentsubsidiary relations
Kareman,2008, Gál, 2010
19
Dependency on parent bank finance:
Out of a “liquidity-crisis mood”, but funding availability and cost remain a
constraint for CEE banking
Banking sector external liabilities
(% on total liabilities, June 2009)
Slovakia
CEE external liabilities(1)
Czech Rep.
Turkey
25%
450
400
Volumes (l.s.)
% on total liab. (r.s.)
20%
Russia
Serbia
Poland
350
300
15%
Croatia
3.5%
8.5%
10.5%
16.0%
17.4%
18.7%
21.5%
250
Bulgaria
200
23.8%
10%
150
100
5%
50
Ukraine
26.8%
Romania
27.2%
Bosnia
0
29.5%
0%
2005
2006
2007
2008
2009F
(1) CEE-17
Source: UniCredit Group CEE Strategic Analysis
Slovenia
30.3%
Hungary
31.0%
Kazakhstan
Lithuania
Estonia
Latvia
32.7%
44.6%
52.5%
53.9%
High level of financial dependency on global (EU) financial
institutions
„Argentina on the Danube” (The Economist , 2009 February)
„Subprime Europe”
“great capitalist transformation” of Eastern Europe has been
expressed over the last decade by a high level of debt and
financial dependence on Western European banks, which is
without precedent since decolonization… Samary, 2009
(Towards a Western/Eastern Europe Banking and Social Tsunami)
„Adopt our ways, the EU said, and you will share our prosperity and freedom.
Eastern Europe responded eagerly. Paradoxically, their very eagerness opened
the way to their current problems. Their adoption of EU rules made leading
banks feel safe to lend to them. Money flowed in, helping the region start
catching up with the half-century it had lagged behind its western neighbours'
economic growth. And then the financial crisis hit. The lending that sustained
east Europe's current account deficits until last year was largely provided by
local subsidiaries of central and west European banks; it has now evaporated.
The region's governments - many of which managed their finances more
prudently than many western countries - find themselves unable to plug the
yawning financing gaps. … Smaller member states are often the most committed
to the EU, but they can do little when their big neighbours cynically undermine
it.” Financial Times, 2009.febr. 19.
21
The dual-banking systems
• CEE suffer from a a “de-nationalised dual banking system”, consisting
of large foreign banks and small local banks (Gál, 2005, 2009; Alessandrini and
Zazzaro, 2009).
• Pros
–
–
–
–
–
–
Acess to resources of parent banks, transfer reputation
Institutional efficiency; efficiency in credit allocation (?)
Contribution to financial/macroeconomic stability
foreign banks branches are channels of modernization
Introductions of efficient rules of governance
More stable credit sources for the local economy during economic downturns?
• Cons
– The „dual banking system” is more prone to transmit adverse shocks across
borders and serves as a propagation channel for potential regional shocks
– Extremely high centralisation of HQ function in capital cities
– Lack of strong locally-regionally based banks: savings cooperatives with weak
financial standing
– Financial exclusion (lower accessibility to services on certain territorial level )
– Transfering adverse shocks across borders
22
Problem originating from a parent banks
during the crisis
1.
Parent banking background is helpful (Haas-Lelyveld, 2009)
– Supportive effects
– Substititional effects (reallocation of bank capital by risk and expected yield)
2. Cross-border lending channels deliver shocks (Goldberg, 2009)
–
3.
Maturity mismatch, lending in foreign currencies (swaps),
–
–
–
–
4.
High loan/deposit ratio
High exposure in foreign liabilities (carry trade, currency swaps) 1000 Bn
USD
Different regulations in parent and subsidiaries’ countries (Highest net
foreign debt of the private sector in Hungary)
Liqudity crisis in CEE, Suden stops in cross border interbank lending
Stages of shock transmission
–
–
•
Foreign banks played a significant role in the transmission of the current
crisis to EMEs
Pre-Lehman Brothers: risk premium, narrowing liquidity, decreasing parent
supply
Post-lehman Brothers: solvency problems, fall in share values, and
downgrading ratings at parent banks
Capital flight? Parent banks generated capital outflow from their
23
Conclusions 1
• Role of FDI/foreign banks in Visegrad+Slovenia financial services:
evolution of a dual banking system (Slovenia: the outlier)
• The role of FDI in economic growth revisited (Balogh, 1982, Rajan et
al 2006)
–
–
–
–
Negative correlation between growth and FDI stocks in EME
Positive correlation between growth and FDI stocks only in developed c.
Foreign bank presence in low income countries generates less credit
During crisis reduce their domestic credit more than domestic banks
• The impact of the dual system during the crisis years revisited in the
framework of the dependent market economies model
• Crisis years: analysis of the geography of the changing network
(parent-subsidiary) relations
– Parent banks generated current account imbalances (substituted local
houshold savings)
– Stronger substitution effects: reallocation of resources within banking groups
(OTP Banks, IMF loan, capital flights?)
24
Conclusions 2
Implications for transformation of the crisis-prone European
financial landscape
• In 2009 CEE was the main crisis spot
• In 2010 EMU in debt and fiscal crisis
• Future of banking subsidiaries in CEE (relocation,
consolidation, Foreign bank exits)
• Increasing role of the nation state (regulation, taxation)
• Weakening states in CEE (no ability to support their banking,
taxation banking)
• To strenghten local financial structures (EBRD CEO warning)