ING CEO sees tough challenges ahead, clouds with silver lining in CEE banking sector (Interview)

As the regional head of ING Bank, what is your view of the economic outlook for the CEE region?

The 2008 crisis hit the region very badly, however its real economy proved more resistant than expected. The CEE region recovered relatively fast, and I believe that it has the potential to become the fastest growing region in Europe. Whilst the crisis of 2008 is already behind us, Europe has been hit by subsequent waves of crisis; however the region has stayed firm. This is because lessons from the earlier stages of the crisis have been learnt.

From a banking point of view, the key question is how the effects of market pressures carry over to the real economy in the near future. Do you see a significant risk in this regard?

This is a difficult question to answer. Just remember those highly interesting debates back in 2009 on what recovery will look like: shapes like L or V were mentioned, as well as a double-dip W-shape. One can only hope that whatever we are facing now is not the second phase of a W; however it has become obvious that recovery will be anything but easy or spectacular. That is, there is a possibility that recession can be avoided, but global imbalances are so great that they certainly cannot be eliminated overnight. I do not believe we are about to enter an era of steady economic growth.

In this environment, adequate capital and liquidity management is more important to banks than ever, and it has been also increasingly required by regulators. On the other hand, a number of reports have revealed that banks’ capital adequacy has actually improved compared with the pre-crisis era, and large sums are sitting in central bank vaults. In light of these facts, don’t you think there has been an overreaction to market processes?

I do not believe banks have overreacted, this is not just a big fuss over nothing. The crisis has taught banks that their earlier practice of lending without considering the potential costs, is not viable any more. They must take several factors into account; allocate capital, liquidity and financing to each product, something they are now also required to do by what I call the new Basel 2.5 regulations. Lending activity is no longer viable without taking the lessons of the crisis and new requirements into consideration.

How do you see the situation of ING Bank?

Prior to the crisis, we had been a great deal more restrained and prudent compared to a number of our competitors. In the current situation, we have to focus on our own business, as any bank does. Our key objective is to serve our clients’ needs, and risk management is part of that as well. We have been lending very cautiously on CHF basis to clients with no CHF income, corporate and retail alike. By now, everyone has realized that prudent risk management is necessary, and unrestrained foreign currency lending does not fit into that concept. In Hungary we do not have retail clients, but we do have retail in Germany, Poland, Romania and Turkey.

Is it possible that you were simply lucky with your timing? If the crisis had started later than it actually did, would ING not have started lending FX like crazy, just like everyone else?

No. I can definitely say this decision was part of our business policy. Of course we saw that the market was growing at a spectacular rate, that most banks saw a huge business opportunity, and several of them were trying to persuade us to jump on the bandwagon, asking why we would want to miss out on this great opportunity. We were cautious enough to give it a miss, and have not regretted it. We clearly saw that in the event of a crisis, the countries active in foreign currency lending could end up in a very difficult situation, and if we were part of that, we might easily find ourselves in a crunch. Again, it is all about prudent risk management and putting your client first. Regarding the future, global macroeconomic unbalances are massive, removing them will be a big challenge, however I am convinced that it will be successful. I do not know whether it will last 10 years or less, but I rather doubt that foreign currency lending will again become big business for banks even in 10 years from now. They have lost too much, this was the big lesson to be learnt from the crisis. The Basel regulations have made me even more confident in this belief, as the rules will spur banks to avoid risks much more than they did in the past.

In the fall of 2008 this region went through a brief liquidity crisis as well. Do you think there is a chance for this to happen again in the coming months?

It is hard to say as no one can see the future. A similar future crisis may happen, but at this point the resulting shocks are unpredictable. It is a fact that the region is plagued by imbalances; in the banking sector this manifests itself most prominently in the shift from deposits to loans. This kind of imbalance does not exist in all of the countries, however it is present in quite a few. The lending boom of the past decade was not coupled with a similar boom in savings. Perhaps this gap is not so wide as the one you see dividing the East and the West globally, however it is still significant, and I believe that it must not be expanded any further; it should be reduced, not increased. Governments should promote retail savings; this is not the time to let nest eggs melt away. This will be hard work, and banks should also encourage retail clients to think in terms of saving instead of borrowing. Meanwhile, economic policy measures need to be put in place in order to foster local money and capital markets, thereby increasing the willingness of the public to save. This may take several years. As concerns foreign currency loans, these will have to be converted, step by step, into local currency loans. Note the emphasis on “step by step".

Talking of which, what is your opinion of the Prepayment Act, which has already cost the Hungarian banking sector approximately HUF 100 billion?

The final prepayment of foreign currency loans is obviously a source of major losses to all banks which generates additional capital requirement. If parent banks refuse to supply that, their local subsidiaries will be left with no other choice than adjusting their balance sheets. This will result in economic slowdown.
Smoothing out imbalances projects a decrease in banks’ profitability, as lending has always been more profitable than deposit taking. In this situation, what could become the engine of growth for the banking sector?
The CEE region will develop faster than other parts of Europe, in spite of the events that took place over the past few years. ING has been present in the region since the early nineties, and as such it has plenty of experience that will enable us to deal with a difficult economic environment. Our clients know us as a trustworthy partner and we know them and their needs. It is not possible to pinpoint one specific growth driver, but we still see opportunities.

However, they are unlikely to manifest themselves in the lending business anytime soon. As far as we are concerned, ING is not predominantly active in retail banking. In Hungary, absolutely not, and in other countries our strength is in the corporate business. Before the crisis, lending had been a growth driver in corporate banking too, albeit to a smaller degree. However in recent years demand has dropped in the corporate sector as well, and capital markets have also responded sensitively. Banks will now have to revise their business models and identify the key business areas they wish to focus on. Moreover, banks will gradually need to explore sources where they can realize non-interest type revenues. This, however, does not mean that lending will suffer forever. Even as we speak, the region is showing signs of very slow but clearly visible recovery in lending. Further, revenues from various activities will be more evenly balanced.

To what extent is scarce capital supply the culprit behind reduced lending activity?

The new capital regulations naturally reduce banks’ lending capacity, however the impact of recent turbulence in Europe has been even greater and more direct. One of the negative consequences, for example, is the fact that American money market funds are more reluctant to invest in European banks than they were before, which is a problem because they an important source of finance to European banks. This phenomenon is forcing financial institutions to significantly reduce the amount of USD lending, among other things. The scarcity of available capital, coupled with a slow increase of demand, results in the repricing of debt, that is, loans will become more expensive in the short run.

In light of the above, to what extent do you think Hungary is lagging behind?

It is not so much behind other countries as many people think. Hungary is no exception to regional trends, demand for loans is similar to other countries. There is no reason to be overly optimistic for the economic outlook, but there has been a small increase in demand. In Hungary we focus mainly on large corporate clients, a large part of which are exporters. At the moment, this sector is also slightly under the weather, but it is still in a much better shape than other segments of the economy. Therefore, we have no reason to be seriously concerned. In Hungary, like in many other countries these days, fees and commission income are playing an increasingly significant role in banks’ P/L statements, compared to interest income.

The crisis has increased non-performing loan ratios. What is your experience in this area?

It holds true not only in ING’s case, but perhaps for all the banks, that the required level of loan-loss provisions is declining due to the fact that the non-perfoming loan ratio is growing slower than it used to. In several segments clients’ creditworthiness is improving already. I believe this is not only the result of a favorable external environment, but also due to the fact that we have always been prudent lenders. Customer centricity is not incompatible with prudent risk management. Another one of our strengths is that ING has a profound understanding of industry-specific client needs, and has remained consistent with the principles it had formerly embraced.

The German economy and the growth of exports is slowing down; do these facts make you pessimistic?

In this day and age you would be hard pressed to find a banker looking to the future with great optimism, but I do not see a reason to be pessimistic either. Of course the region is looking at Germany which, being the largest economy in Europe, plays a major role in generating demand for the products of companies we finance. Similarly, Germany is the engine that drives Europe’s economy. The crisis is a crisis for all of Europe, so it cannot happen that the German economy is rocking while all other countries in Europe are in a deep crisis. Consequently, a final solution to the debt crisis in Europe will very heavily depend on how Germany is performing in the years to come.

How do you see M&A activities in the banking sector? Is Hungary going to experience the same trends as Poland has, where the market is buzzing with activity as banks change owners?

Looking at the region, the biggest mergers are probably behind us already; in this respect the years immediately preceding the crisis were the most active ones. International expansion had once been driven by acquisitions. Those times are over. Mainly in the USA, but partly in the CEE region too as regulatory pressures dictate most of M&A activities. The reason some bank or another needs to merge or make acquisitions is that the powers that be see it fit. I am not expecting major acquisitions or mergers in Hungary or elsewhere in the region in the near future. The position of financial conglomerates is today largely determined by the EU debt crisis, impacting their M&A activity more than anything else. Furthermore, by now acquisition targets have become thin on the ground. Hungary is a smaller country than for instance Poland, and banking groups see their local subsidiaries merely as part of their regional portfolios. That is probably the main difference between Hungary and the much larger Polish market.

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