Keeping the Floodgates Closed

The short-term outlook for the banking industry in Central and Eastern Europe is reassuring, but the financial industry has grown more cautious with respect to lending despite a supportive macroeconomic and industry backdrop, Kevin A. Murray, Chief Executive Officer for Central Europe and Country Head for Hungary tells Diplomacy&Trade.

In recent years, countries in Central and Eastern Europe have confirmed their ability to continue to generate growth. Markets expect economic expansion to stay elevated this year and the region to consolidate its position as the champion of growth in the European Union. The favorable macroeconomic backdrop, with GDP growth rates expected around 3% or above in 2019, has a beneficial impact on the region’s financial industry, which looks set to boost its bottom line further, Murray says. “The outlook for the sector is pretty positive for the next 2-3 years. By and large, we have good and improving portfolios, non-performing loans (NPLs) are definitely moving in the right direction, interest rates are still low, and the CEE is growing 3-5% or more in terms of GDP. I don’t think this will go on forever, but I do believe that at least for this year and next – unless something unforeseen happens –, we’ll see GDP rates of around 3%,” Murray notes. He cautions that a potential recession in the EU or a significant deterioration in America’s trade dispute with China, leading to a hard landing in the latter’s economy, could disrupt this process.

The improvement in banks’ asset quality is evidenced in NPL ratios gradually trending back to single-digit figures or even converging to pre-crisis levels in some countries, according to a study by Deloitte published on its website. This was also stimulated by the recovery of lending activity driven by the continued positive trends in the macroeconomic environment, the study says. In Hungary, corporate credit surged 13.6% annually in the last quarter of 2018, an exceptionally high rate in the region and the highest in the past 10 years in the country, the National Bank of Hungary said in a study entitled 'Trends in Lending', published in March this year.

Despite the supportive economic environment and historically-low interest rates, banks are more cautious when it comes to lending, having learnt the lesson of the 2008 financial crisis, Murray says. “Central banks strongly support lending, but I think banks are sitting back and saying we have to be cognizant of the risks and not open the floodgates. With some products, the price may be going up again, close to levels where people start to get worried, but the capital base is much bigger and banks are much safer. Compared to 2008, Citi is smaller, certainly more efficient and a lot safer.”

Can’t fall asleep at the switch

Tight labor markets, however, are tainting the positive economic picture across the region. The lack of skilled workers and continued emigration to Western Europe are putting a strain on economies from the Black to the Baltic Seas. “Attrition is a concern that we monitor closely,” Murray says. “All of us at U.S. financial institutions in the region feel the pressure, but we feel our prominence in the market gives us a bit of an edge. Core banking functions – products, compliance, middle office functions, are pretty steady. That is great but you can’t fall asleep at the switch, you have to watch salaries and job content or you find yourself way behind the power curve.“

Hungary has had double-digit wage growth for nearly two years and economists see the trend remaining in place at least for this year. “Just from an expense aspect, you look at wages and your first reaction may be a negative one, but, in fact, the increase we see is a good thing. If you narrow the wage gap with Western European countries, people in CEE countries have less incentives to leave or if they do, they come back,” according to Murray.

Friend or foe?

Technological advancement and the ceaseless emergence of fintech companies offering services that disrupt the banking market are a challenge that incumbents can ill afford to ignore if they want to stay competitive in the digital age. “It’s important to see fintech companies as partners. They have some great ideas and we have to listen to them because some of those ideas will make us more efficient,” Murray says. Citi operates three innovation labs in EMEA, and part of their day-to-day business is to monitor start-ups, test them out and occasionally offer the possibility of working together. “I don’t think these companies will eat into established banks’ market share.

Banks have an established construct including compliance, risk and infrastructure to support all aspects of the economy. Nevertheless, we have to learn from them; some banks will fall to the wayside if they don’t learn.”

Good place to do business

Hungary’s solid economic growth in recent years and more predictable government policies are appealing to foreign investors, as testified by FDI inflows, according to Murray. “Hungary is a good place to do business. Would I like to see a few things changed? Yes. I’d like to see the bank tax removed and it would be nice to see other tax changes on the municipality level that support service centers coming into the country.”

The central bank’s dovish policy helped pump liquidity into the markets and keep the GDP momentum going. Looking ahead, inflation and the ECB will be crucial for local monetary policy evolution, Murray says. “Inflation is starting to pick up and once the central bank’s most refined inflation indicators get uncomfortably close to the upper limit of the central bank’s range, they will be more pressurized to start to increase rates.” The government’s decision to draw down EU funds as early as possible “was foresightful, as the impact of the implemented projects will start to kick in around the time the EU fund inflow declines,” Murray says.

Having set up its business in Hungary in 1985, Citi was one of the first foreign investors to establish a banking presence in the then Communist country. Although the New York City-based lender has scaled back its operations both in Hungary and the CEE region by exiting the retail banking market, the bank continuously offers a range of products and services to large local corporations, SMEs, multinational clients, financial institutions and the public sector. In addition, Citi’s shared service center, established in 2005, provides services in the areas of technology, operations, risk modelling, analytics, finance, among other things for Citi-entities around the globe.