Europe – The Final Countdown

In a characteristically provocative address last month, the Czech President and current holder of the rotating EU Presidency, Vaclav Klaus announced that he “rejected the uncriticisable assumption that there is only one possible and correct future of … deeper and deeper integration.” It was a sentiment that reflected a growing Eastern European resentment towards what has been considered the EU’s “Soviet” interference in domestic politics. But, as western European banks consider whether to abandon their eastern European subsidiaries, Klaus’ demands may well be met sooner than he might have expected.

{{ quote In some senses, the EU’s political ambitions may well be shot down by its very own economic bullet. }}

Western banks’ control over central and eastern European bank assets is unprecedented. Figures released by the credit-rating agency Moody suggest that over four-fifths of bank assets in Eastern Europe are foreign-owned. And now as western banks begin to recoup their losses, western banks are looking to shed these liabilities.

Eastern Europe presents a number of risks for Western banks. The first and most obvious threat is a run on the banks. This could in turn jeopardize the bank and render it inoperable, which at the very least, would demand western banks to cough-up the capital and liquidity that they simply cannot afford.

At the same time, western banks would have to soak up the bad debts that arise as local customers begin to default. This has certainly already began in this country, where for example, the number of houses being reclaimed has risen sharply by over 400,000 homes. But why this is particularly significant for European banks is due to the fact that many eastern European customers have borrowed in foreign currencies that have since risen relative to their own. As such, these debts are likely to be relatively higher.

Moreover, foreign-exchange mismatches are also likely to mean that assets of local banking subsidiaries will shrink relative to liabilities. This eats up capital and simply serves to worsen banks’ balance sheets.

These factors are likely to lead banks to begin dropping their subsidiaries. And if this is the case, break-up beckons, which could prove disastrously for domestic economies. But contained within this is the even more frightening possibility that this private fragmentation will spill over into political disharmony. For if western parent banks abandon their eastern European children, national governments will inevitably be left to pick up the pieces, which could lead to the collapse of the euro itself.

This can be done. The Belgian, Dutch and Luxembourg governments’ successful bail out of Fortis back in September exemplified the fact that the cross-boundary administration of a bailout is possible. However the Benelux operation not only demanded funding but also a preexisting working relationship with the EU that Eastern European countries do not currently possess.

Instead the ensuing chaos that would follow from these banks’ collapse would only exacerbate eastern Europe’s reluctant dependence upon the Bundesbank. And in doing so would stoke the fires of increasingly popular nationalist movements that have recently begun to emerge – and which Klaus’ statement echoed. For despite the Austrian banker, Ewald Nowotny’s recent reassurances at the Warwick Summit last month that the European Central Bank could cope with the pressures of the current crisis, his words may have underestimated the resentment that the one-size fits all strategy has provoked. In some senses, the EU’s political ambitions may well be shot down by its very own economic bullet.

That is if western (private) banks completely abandon east Europe. We forget that the worse risk over all for a bank is the fear of loosing its reputation, upon which it ultimately depends to draw depositors; especially in a climate like this one. When, for example, the Argentine government defaulted in 2001, some blue-chip companies allowed their local subsidiaries to fail—France Telecom and Telecom Italia let Telecom Argentina default. But big western banks, like Santander, held firm and are now reaping the dividends. All of which suggests that banks will do their utmost to back their subsidiaries.

The EU may be safe for the time being, but the biggest test will come in the European elections later this year when western states will have to sell the bailout to very reluctant taxpayers.