Austria Revives Debate on Shielding Banks From Eastern Loss

(Bloomberg) -- Austrian banks, whose rush into eastern Europe after communist rule ended made them among the biggest lenders in the region, are poised to return to a decade-old debate over who pays for a local unit’s failure, a top central banker said.

Austrian authorities believe eastern European host countries should manage eventual failures of subsidiaries within their borders and make sure costs are covered with locally issued securities, effectively shielding the banking parents and Austria, central bank deputy Governor Andreas Ittner said in an interview. Total assets for Austrian banks’ eastern holdings amount to about 200 billion euros ($247 billion), or two-thirds the size of the country’s economy, according to the central bank.

“This approach corresponds best with the structure of Austrian banks,” Ittner said. “They have local subsidiaries with local funding and therefore the responsibility should be local too. The units should remain locally anchored.”

For bankers and regulators, the debate is a deja vu of the global financial crisis. Profits for Vienna-based lenders such as Erste Group Bank AG, Raiffeisen Bank International AG and UniCredit Bank Austria AG soared as a return to a region once dominated by the Austro-Hungarian Empire was marked by a surge in borrowing to catch up with the west. That boon turned to risk for Austrian state finances when bad debts soared after 2008 and the survival of banks seemed at stake. In March 2009, Austria’s sovereign risk was seen as higher than Italy’s and Greece’s.

Austria Revives Debate on Shielding Banks From Eastern Loss

The central bank hit the brakes and imposed limits on how much liquidity the banks’ Vienna headquarters could pass on to their eastern units, effectively forcing them to fund credit mostly with deposits. Some of the host countries fumed and blamed Austria for pushing them into a credit crunch. Ittner said the step was prudent.

Austria Revives Debate on Shielding Banks From Eastern Loss

“It’s economically sensible,” he said. “If an economy can’t develop sufficient local funding for loans, it’s more vulnerable to external shocks.”

While business is now robust in the region, essentially the same fight is looming again -- this time because European Union bank failure laws require preparations that have consequences even before a crisis hits. This includes two crucial decisions: which country is dealing with the failure and its aftermath, and who covers the resulting costs.

Favored Approach

The approach the Austrians favor, known as Multiple Point of Entry, works like this: if a unit hits severe trouble and the parent isn’t willing or able to rescue it, host country authorities take over and rescue the “good bank” in a pre-packaged deal under new ownership.

Toxic assets would be wound down at the expense of owners and some creditors under this approach. That would cap the loss for the parent and avoid the risk it’s forced into serial bailouts and accumulate deficits in Vienna -- ultimately even putting the parent itself in jeopardy.

Recapitalizing Banks

The MPE approach requires that the foreign units are pre-stuffed with loss-absorbing debt, known as MREL, or Minimum Requirement for Own Funds and Eligible Liabilities, earmarked to mop up losses and recapitalize the “good bank.” Some host countries think those bonds should be bought by the parent. But that would be unfair, Ittner said.

“One can’t chose an MPE approach but then force the parent to buy all the MREL,” Ittner said. “That would be unbalanced because the local authority has full control, while the losses are being borne by the headquarters.”

To be sure, with bond markets in most of eastern Europe still nascent, it could be hard to find investors to buy MREL, Ittner said. In that case, institutions such as the European Bank for Reconstruction and Development could be the first buyers. It would be acceptable for parents to buy them for a limited time, he said.

Ittner declined to say with which countries the discussion is most difficult. Austrian banks are among the biggest lenders in the Czech republic, Slovakia, Romania and Croatia. At any rate, he warned that if demands are unreasonable, banks could decide to turn subsidiaries into branches, which would be undesirable both for Austria and for host countries.

“The extreme alternative would be branchification,” Ittner said. “That shouldn’t be our goal, but the banks have this option if it comes to that.”

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