La lingua batte dove il dente duole. The tongue always finds the aching tooth. No-one can help thinking and talking about worries and fears, hoping to chase them away, almost to exorcise them. Clearly the EBRD is very worried about the possible withdrawal of funds by foreign banks from transition economies. Its officials keep talking about this, ambivalently both envisioning the dangers and denying them in the same breath. Economics can be controversial: if it is quite common for an economist to disagree with herself, it is even more common for an international financial institution, like the EBRD. But for an outsider this insistence is a very worrying signal indeed.
On 7 May 2009, inaugurating the newly founded EBRD blog, the Bank’s Chief Economist Erik Berglof strikes a pre-emptive attack: “Eastern European governments can … damage the international bank groups by preventing them from transferring profits or adjusting their exposures. The public pressures to interfere are great.” And in the EBRD Press Release on the same day, Berglof notes that “Over the past six months important bank bailout programmes in Western Europe have helped stabilise the international banks operating in Eastern Europe” and assumes “continued external engagement, particularly from the western parents of banks in the region”.
I pointed out, in a Comment, that in turn “international bank groups can damage Eastern European governments by the abrupt withdrawal of funds in a crisis.” And that the EC Spring forecasts 2009 tell a different story: “The repatriation of capital by foreign banks has been particularly abrupt in some cases. …the presence of EU banks in the region creates further potential negative spill-overs via the financial channel” (p.22). And “If a foreign bank with big exposure to the region—Swedish, Austrian or Italian—needs to raise more capital but finds that outsiders think its loan book is too risky, what happens? The price of rescue may be that it sheds a troubled foreign subsidiary. Signs of shareholder twitchiness are growing“ (The Economist, 26 February 2009). Not unnaturally, when capital becomes scarcer in the country of origin, foreign capital tends to go back home.
Berglof readily admitted the problem: “I do indeed think that there is a serious risk that some banks could decide to withdraw or be forced to withdraw from the region. We should not kid ourselves, the forces on the banks to retrench are extraordinary - some deleveraging and adjustment to lower credit demand is unavoidable and essentially healthy.” He actually strengthened the point adding that “The current situation has elements of a prisoners’ dilemma where the banks as a collective want to stay involved, but in the short-term an individual bank has incentives to be the first to withdraw.” But he relied on the “Vienna Initiative” (illustrated in his post) and other forms of concerted and conditional support by international financial institutions.
On 14 May 2009, at the Bank's Economic Policy Forum, EBRD President Thomas Mirow took comfort from the fact that, in the “spectacular slump which now seems to suggest that the only way is down” – and which he regards as exaggerated as “the earlier spectacular success when the only way seemed to be up” – “we did not see the withdrawal of any of the leading western banking groups who own most of the financial sector in eastern Europe.” This he attributes to “the fact that financial integration generally went along with long term commitments, particularly on the part of international banking groups”. “A measure of the progress achieved so far is the fact that the danger of large-scale retrenchment or withdrawal of western parent banks from eastern Europe has been averted and seems more unlikely now than only a few months ago”(my Italics throughout).
The trouble is that on 11 May two other EBRD officials, Piroska Nagy and Stephan Knobloch, in an excellent post on the EBRD Blog, on “BIS data on cross-border flows” produced substantial and disquieting evidence of the seriousness of cross border outflows. In the last quarter of 2008 BIS-reporting banks significantly reduced their asset holding across major world regions ($1.8 trillion or 5.4% of their stock). In absolute terms advanced countries were hit harder ($1.3 trillion), but in relative terms emerging markets did worse. So far the EBRD region was the least affected, but the decline ($57 billion) was “still very significant”.
Moreover, within Emerging Europe: 1) the decline was concentrated on a few countries: Russia, Turkey, Ukraine, as well as Poland, the Czech Republic, and Slovenia; 2) the decline happened in the most financially integrated countries, not necessarily in countries with weaker fundamentals, “with large outflows both from countries that have already been hard hit by the crisis (Ukraine) and countries that have been resilient so far (Poland)”. “This is in line with earlier crisis experiences which showed that investors withdraw liquidity not only from countries with weaker fundamentals but also from markets in the same region that are deeper and more liquid” (Nagy and Knobloch, Ibidem). Thus asset outflows in the last quarter of 2008 were 15.5% of the stock in Russia, 9.4% in Ukraine, 8.2% in Poland, 7.5% in Turkey (which is also a country of operation for the EBRD), 7.2% in the Czech Republic, 4.1% in Moldova. In absolute terms, the outflow was $33bn in Russia, $12bn in Turkey, $11bn in Poland, $4bn in the Czech Republic and in Ukraine.
Data refers to all cross-border loans, deposits, and securities held by bank offices located in one of the 41 BIS-reporting countries. This includes assets held vis-a-vis all economic sectors, i.e. private and public, or bank and non-bank. BIS uses the category "developing" countries; this note uses "emerging" countries instead.
“Looking forward, – Nagy and Knobloch conclude – similar trends are expected to have continued – if not deepened - in Q1 of 2009. De-leveraging is an inevitable part of banks’ balance sheet adjustment in the context of the global financial crisis.” While the average picture is reassuring, for the individual countries where the phenomenon is concentrated it is intensely worrying.
But this is not the end of the story. If the post by Nagy and Knobloch pulls the rug from under their President and the Chief Economist, Piroska Nagy adjusts her aim with another post, on “The ‘invisible hand’ of advanced country central banks in emerging markets”, while EBRD senior economist Ralph De Haas writes another post “In defense of foreign banks”.
Piroska Nagy notes that “most emerging market economies have limited policy room to deliver massive counter-cyclical crisis response”, but “there is an invisible channel through which advanced country quantitative easing can benefit emerging markets”, trickling down to subsidiaries of international banking groups. She regards the “invisible hand” of the European Central Bank as particularly important.
I would argue that the ECB hand is, indeed, invisible, because it is not there. The ECB is notorious for not having the function of Lender of Last Resort, which rests with the national Central Banks for their national banks, leaving open the thorny and often unanswerable question of bank nationality. True, the ECB is often said to have functions of ELA - “Emergency Liquidity Assistance”, understood as lesser responsibilities than those of Lender of Last Resort – except that the IMF uses the two expressions interchangeably. Willem Buiter worries about who would re-capitalise the ECB if it went bankrupt; I worry about the impossibility of the ECB ever going anywhere near bankruptcy as a result of its non-existant operations as Lender of Last Resort, with Eurozone banks going bust instead.
And anyway, quantitative easing does not seem to work in the Eurozone, as banks are still reluctant to lend; why should liquidity trickle down into Emerging Europe. Furthermore I have heard other promises, for instance of prosperity trickling down, but I have also come across trickling up. Quantitative easing by the ECB and national Central Banks in Europe is much more likely to spill-over into a commodity price boom than into Emerging Europe.
Finally, in his post In defense of foreign banks, Ralph De Haas distinguishes between cross-border foreign bank lending, which he recognises does shrink during the crisis, and local lending which he regards as generally more stable. He refers to a 2004 study which he co-authored to argue that in central eastern Europe “reductions in cross-border credit were generally met by increases in lending by foreign bank subsidiaries”. But that was then and this is now, and much worse than then; and in any case foreign and local funds are not perfect substitutes, for local funds do not help the stability of the currency.
So, now we know. The EBRD President, its Chief Economist, the Senior Adviser to the Chief Economist and her co-author, and at least another Senior Economist, go to considerable lengths to tell us that there might be trouble ahead, but to reassure us that all is under control, and that foreign banks will behave selflessly, readily and adequately to support and stabilise credit in Emerging Europe. Excusatio non petita accusatio manifesta, as it were.
Clearly they are all worried stiff, and so they should be. I wonder if there is an agreed plan for providing Emergency Liquidity Assistance to one of the Currency Boards of Emerging Europe if it went bust; there should be one. Or two.