Credit boom benefits E.Europe, pitfalls lurk-EBRD

By Sujata Rao

LONDON, Nov 13 (Reuters) - A huge increase in availability of bank loans has benefited households in the former Soviet bloc but high credit-growth levels and the dominance of foreign banks could become a worry in some countries, the EBRD said on Monday.

The European Bank for Reconstruction and Development estimated credit to the private sector had increased by 70 percent in central Europe and Baltics and had almost doubled in southern Europe between 2000 and 2005.

But the growth rate of household credit as a proportion of gross domestic product far outstripped loan growth to enterprises, it said in its annual transition report.

In central Europe and the Baltics for instance, loans to households swelled by 192.6 percent of GDP in this period while in the ex-Soviet Union they grew 585.4 percent of GDP, the report said.

The bank, set up in 1991 to aid the transition of Communist bloc countries to capitalism, outlined some worrying trends, such as the practice of lending in foreign currency.

In Croatia for instance over 70 percent of household loans are denominated in foreign currency, it said, noting this left households exposed to currency risk.

"Rapid growth in credit in recent years in Bulgaria, Hungary and the Baltic states has raised concerns over stability and risk-taking. High credit-growth in transition countries, even if welcome in terms of long-term development, can trigger serious financial and balance-of-payments problems," the report said.

The study found that enterprises had benefited less from the credit boom, with up to 60 percent of small firms in the transition states having little or no access to bank credit.

And despite steady private sector credit growth, transition states lag behind countries with comparable income levels, it said, adding: "An underdeveloped financial sector penalises in particular the activities and sectors that require external financing to operate efficiently."

FOREIGN BANKS

The transition states have seen an influx of foreign banks, which in some of the countries account for over 80 percent of sector assets.

Foreign banks have invested billions to expand in the former communist bloc, which offers margins and growth unimaginable in the west. For instance, retail loan growth in Russia is forecast at over 50 percent a year, versus 6 percent in the euro zone.

The EBRD report found that foreign banks also tend to concentrate on the household credit sector.

"Foreign entrants.. tend to have poor information on local borrowers especially small firms, and may restrict their lending to larger enterprises often branches of foreign multinations," it said. "Moreover foreign banks tend to focus on household loans as relatively little information is needed for these and no collateral is generally required."

Overall, foreign banks have positively impacted transition states' financial systems, the EBRD said, noting foreign bank ownership also often diminishes the likelihood and impact of future financial crises.

But the flip side is that dominance by a small number of multinational banks means any future economic downturns may be more easily transmitted from one country to another.

The bank noted that as many transition states were dominated by the same Western European banking groups, "potential contagion effects could be quite large".

"A potential danger is that the objective of getting local market share may, in some cases, contribute to macroeconomic imbalances. In a number of transition countries...rapid growth in household lending has contributed to rising current account deficits and asset price inflation," it warned.

((Reporting by Sujata Rao London Newsroom +44 20 7542 6176 sujata.rao@reuters.com; Editing by Gerrard Raven))

Keywords: ECONOMY EBRD FINANCIAL