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Banks Cannot Thrive In A Stagnant Economy

At the start of this decade, foreign banks were the biggest investors in Serbia, while today we are increasingly witnessing the departure of these banks from the domestic market. This month we spoke with Dejan Šoškić, a professor at the University of Belgrade’s Faculty of Economics and former governor of the central bank, about the factors that have led to such a disappointing turnaround.

How do you interpret the key factors leading to this trend?

– There are several factors that have contributed to this situation. First of all, the global financial crisis placed a strain on financial institutions worldwide and contributed to increased losses among many banks and other financial institutions, both in the U.S.and also in Europe, where most of the parent banks of those operating in Serbian originate.

The global financial crisis was followed by the Sovereign debt crisis in Europe, and that placed additional strain on European banks, especially Greek banks, which also had subsidiaries in Serbia.

The new stricter European banking regulations in the aftermath of that crisis provoked deleveraging and a more conservative outlook among most European banks towards their international networks and expansion. However, these were not the only factors contributing to the current situation.

On the internal side, the Serbian market has proven to be relatively limited in terms of development potential. A stagnant economy, weak institutional framework, low financial reporting standards and underdeveloped, and sometimes inadequate, rule of law have all proven to be significant limiting factors on the development of banking. In addition, in terms of the number of banks, the Serbian market was relatively dispersed and prone to mergers and acquisitions even before the crisis.

At that time, as was to be expected, the biggest investors were banks from Austria and Greece, while it could also have been expected that after them, once the market had matured, some German and possibly American banks would arrive. However, such a flow of events, as was seen in Eastern European countries, didn’t happen here. Why?

– Yes, it was normal to expect that banks originating in neighbouring countries (Austria, Italy, Greece, etc.) would react sooner and enter the market before other banks. Larger banks from Germany, the U.S. or UK are global players and must see their clear interest before opting to enter any specific national market.

The Serbian market is relatively small and is regulated in such a way that foreign banks cannot open branch offices, rather only subsidiaries (separate legal entities) or representative offices. Under such circumstances, large international banks that are disinterested in retail banking development in Serbia could opt to stay out or just have a representative office in the country, as we have witnessed as being the case with some of them. On the other hand, it is not clear that additional banking capacity in Serbia (coming from Germany, the U.S. or UK) would generate additional benefits in terms of real sector development. Even the current financial capacity of banks operating in Serbia is underutilised.

Nevertheless, Russian and Turkish banks began appearing on the domestic market, especially after the financial crisis, and the Bank of China also recently launched operations in Serbia. Was this diversification primarily influenced by global trends or the need of foreign banks to follow their investors?

– Perhaps both. Banks coming from China, Russia or even Turkey were not exposed to heavy losses due to the global financial crisis and European Sovereign debt crisis. Therefore, they have not been exposed to pressure to deleverage and the pressure of the new European banking regulations, as was the case for banks originating in the EU.

It is also important to note what is going on in terms of economic growth in the countries of origin of the banks that are approaching, or are present on, the Serbian market. If growth is relatively low, as was the case in the EU in the years following the crisis, banks coming from these countries find it hard to have an “expansionary mentality”.

On the other hand, banks coming from the countries you mentioned are in a different position, because their countries are in a different economic and strategic position. Russia had steady and robust economic growth until the collapse of oil prices and the imposing of economic sanctions by Western countries, but it has traditional ties in the region. Turkey has been growing quickly for more than a decade and has ambitious expansion plans in its European neighbourhood, i.e. Southeast Europe. China, much more than the aforementioned two countries, is not just a global economic powerhouse but has tangible long-term and very ambitious economic development projects involving Central and Southern European countries. 

You are a member of the Governing Board of Bank of China Srbija JSC. To what extent can it be said at this juncture that it is important for Serbia that the headquarters of the Bank of China for the Balkans and Europe are located in the country?

– The Bank of China is one of the largest banks in the world. Its presence in any national market is, therefore, a good signal for the country and its financial system. Being chosen as one of the countries in which the Bank of China has opened its subsidiary is an important thing for Serbia. This is not just an issue of financing Chinese projects in the region, but also opening opportunities for Serbian companies.

As for Serbia’s financial system, the diversification of banks operating within the system is a good thing; it limits dependence on one large financial centre and also limits the impact of its potential negative spill-overs onto the domestic financial system.

China is not just a global economic powerhouse, but also has tangible long-term and very ambitious economic development projects involving Central and Southern European countries.

Just as there were years of debate over whether it was necessary to close four state banks in the early 2000s, thus today there is a debate, with somewhat less intensity, about whether it is wise to sell Komercijalna Banka – the only major bank in which the state owns a significant share. What is your opinion?

– The necessity to close the four state banks in the early 2000s is a different problem compared to the potential sale of the government’s stake in the equity of Komercijalna Banka.

The former was an unavoidable move if there was no additional capital to recapitalise those four big ailing state banks. It was not a sale since there was nothing to sell – due to the negative net asset value of these banks.

The situation with Komercijalna Banka is different. The government has an equity share in this bank and can decide to sell part or all of that. This government ownership stake is substantial, so it has effective control of the bank. In my opinion, the Government can only keep its ownership stake in companies (both in the financial and real sectors) if it proves capable of imposing effective corporate governance and acting as an effective agent in the name of taxpayers. If this is not the case, then privatisation is an obvious long-term preference, with benefits both for clients of these companies and for taxpayers.

I do believe that effective corporate governance in state-owned companies is possible, but it demands a developed institutional framework and effective public oversight.

Do you consider that the best moment to sell Komercijalna Banka has passed? Given the circumstances, do you expect a buyer for this bank to come from the ranks of players already present or new ones?

– The banking business in Serbia has not been growing in recent years, nor has it proved to be very profitable. If we combine this with the stagnant Serbian economy in past years, it is no surprise that it is not easy to sell banking businesses in Serbia these days. However, things may change, while potential investors might also have different perspectives and interests.

It is vital that every potential new owner of a bank in Serbia fulfils the criteria of credibility, competence and long-term dedication to the development of banking business. Banks that are already present have an advantage as potential buyers since they know the market. However, as Komercijalna is one of the largest banks, local takeovers may pose a threat to the future competitiveness of the market.

The current dispute over the processing of the costs of credit is not good, and no one is innocent in this dispute, neither the banks nor consumers and regulators.

Despite interest rates remaining low, the economy is borrowing very little, and even citizens, who were until recently very willing to borrow, are now taking credit only rarely. Will this lead to further departures of foreign banks from the domestic market?

– You are right. Credit growth is very low, and at certain points, in the previous few years, it has even been negative. The reason for this primarily lies in very low investments and a stagnant economy. Serbia is lagging behind in terms of the share of investments in GDP and – with a level of around 18% – we are at the bottom of the list in Europe.

The similarly gloomy analysis appears when we compare ourselves with the rest of our region, Europe and the World, in terms of GDP growth rates in past years. Serbia has one of the lowest growth rates in Europe, among the lowest in the region and especially among European post-transition economies. According to the IMF, the world economy is expected to grow by around 3.9% this year.

In comparison, Serbia grew by only 1.8 to 1.9% in 2017. In a stagnant economy, with relatively low investments, both households and companies tend not to borrow from banks. And that is precisely what we see in Serbia. If this persists in the medium to long run, it will unfortunately but naturally lead to more foreign banks considering their withdrawal.

Under such conditions, what makes banks in Serbia and the surrounding countries interesting to domestic private owners?

– Local private entrepreneurs have expressed interest in banks continuously in the past. However, Serbia and other similar countries, unfortunately, experienced cases of bank failures due to bad corporate governance on the part of local private owners. It was sometimes the case that so-called “tycoons” considered buying and operating a bank predominantly as a source of growth for their own business empires. That, naturally, is strongly contradictory of prudent banking behaviour.

Financial stability risk, and the potential costs to taxpayers arising from such behaviour, is high. Of course, it would not be fair to propose that all domestic private owners would behave in such a way, but regional regulators must be cautious and vigilant, due to bad experiences from the past.

In your opinion, could the current dispute over the processing of the costs of credit, which is threatening to reach Strasbourg, have a long-term impact on the operations of the banking sector?

– What is happening is not good, and no one is innocent in this dispute. Banks should have realised that charging various (and often relatively high) fees, besides interest, is not good for their long-term relations with their clients (which could rightfully perceive this as deceptive and being in bad taste).

On the other hand, clients are mature people who know the seriousness of a signature freely placed on a contract. In addition, they knew the hole price of credit in the form of a so-called “effective interest rate” that was clearly advertised for every credit product. Moreover, the regulator could have intervened earlier and not shied away from administrative (prohibitive) measures in response to unacceptable behaviour in the marketplace.

For example, loans in Swiss Francs were prohibited and the Law on the protection of users of financial services enacted only in 2011 (when I was serving as NBS Governor), but those things should have been done earlier. Finally, our legal system isn’t innocent either. A lack of sufficient understanding of banking issues and various decisions made by our courts on the same issues do not send a good message. Legal uncertainty is not good for business.
As we can see, most of our economic and financial problems are caused by problems also noted in the EU Commission Report on Serbia for 2018.

Therefore, more effective effort towards EU integration will also help alleviate problems of low economic growth, investments and the development of the financial system in Serbia.

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