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PP RUEHAG RUEHAST RUEHDA RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA RUEHLN
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DE RUEHVI #1852/01 3520827
ZNR UUUUU ZZH
P 170827Z DEC 08
FM AMEMBASSY VIENNA
TO RUEHC/SECSTATE WASHDC PRIORITY 1711
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
INFO RUCNMEM/EU MEMBER STATES  PRIORITY
RUEHZL/EUROPEAN POLITICAL COLLECTIVE PRIORITY

UNCLAS SECTION 01 OF 04 VIENNA 001852 
 
C O R R E C T E D  C O P Y (DROPPED CHAR) 
 
SENSITIVE 
SIPDIS 
 
TREASURY FOR FTAT, OCC/SIEGEL, AND OASIA/ICB/ATUKORALA 
TREASURY PASS FEDERAL RESERVE, FINCEN, AND SEC/JACOBS 
 
E.O. 12958: N/A 
TAGS: EFIN AU XH
SUBJECT: Banking in Central/Eastern Europe: Austrians 
to Stay the Course, But Say Risks Abound 
 
REF:  VIENNA 1751 and previous 
 
Sensitive but Unclassified - Entire Cable. 
 
¶1.  SUMMARY.  The financial crisis has triggered 
concerns about Austrian banks' huge exposure -- over 
EUR 250 billion -- to markets in Central, Eastern, and 
Southeastern Europe (CESEE) and the former Soviet 
Union (FSU).  Austrian banks (and the GOA) argue they 
can manage the increased risks, because they have a 
solid base of deposits and equity, including GoA 
equity injections, sufficient to weather problems in 
CESEE/FSU subsidiaries.  Despite the global economic 
downturn, the CESEE/FSU outlook is generally better 
than for Western Europe and a region-wide recession is 
not expected.  Austrian banks are determined to remain 
in eastern markets, which they say are still under- 
banked and offer growth potential.  An IMF "stress 
test" showed considerable resilience of the Austrian 
banks against shocks.  All Austrian banks active in 
CESEE/FSU are "system-relevant" in Austria meaning the 
GoA will not let them collapse.  Still, banks here do 
not rule out 1997/98-style crises, particularly in 
Ukraine, Hungary, Bulgaria, Romania, Croatia, and 
Kazakhstan.  END SUMMARY. 
 
¶2.  This cable is based on meetings of Embassy 
officers with representatives of several large 
Austrian banks with CESEE/FSU operations, information 
from the Austrian National Bank/OeNB, new CESEE/FSU 
reports of commercial banks, and other sources. 
 
- - - - - - - - - - - - - - - - - - - - 
Position of Austrian Banks in CESEE/FSU 
- - - - - - - - - - - - - - - - - - - - 
 
¶3.  According to the OeNB's Financial Stability Report 
(released December 15), Austrian banks' Tier 1 capital 
ratio in June 2008 was 7.4%, the consolidated capital 
adequacy ratio 10.8%.  Twelve Austrian banks operate 
73 fully consolidated subsidiaries in CESEE/FSU, of 
which 37 are in the 12 new EU member states, 23 in 
other SEE countries and 13 in FSU.  Austrian banks 
have a 15.2% share of the entire CESEE/FSU banking 
market (21.8% excluding Russia).  CESEE/FSU accounts 
for 28.5% of Austrian banks' total consolidated 
assets, but reaches 40% and more for the five large 
Austrian banks active in CESEE/FSU (listed below). 
NOTE:  Unconsolidated bank assets of banks 
headquartered in Austria were EUR 972 billion in June 
2008; total consolidated assets (i.e. including 
CESEE/FSU subsidiaries) were EUR 1,162 billion, of 
which the five largest Austrian banks accounted for 
63.3%.  END NOTE. 
 
¶4.  Five of Austria's six largest banks are major 
players in the region: 
-- Bank Austria/BA 
-- Erste Bank/EB 
-- Raiffeisen Zentralbank (through its consolidated 
subsidiary Raiffeisen International/RI which handles 
the Raiffeisen group's CESEE/FSU business) 
-- Volksbanken, and 
-- Hypo Alpe Adria/HAA 
Examples of Austrian dominance in CESEE/FSU: 
-- BA is the largest bank in Bosnia-Herzegovina, 
Bulgaria and Croatia, number three in Kazakhstan and 
four in Czech Republic and Ukraine 
-- EB is number one in Romania and Slovakia, two in 
Czech Republic and three in Croatia 
-- RI is number one in Albania, two in Kosovo, Serbia 
and Ukraine, three in Belarus, Bosnia-Herzegovina, 
Romania and Slovakia, and four in Bulgaria and 
Croatia. 
NOTE: BAWAG, Austria's number five bank, has 
subsidiaries only in Hungary and Slovenia. 
 
- - - - - - - - - - - - - - - - 
Subprime Versus CESEE/FSU Risks 
- - - - - - - - - - - - - - - - 
 
¶5.  The subprime crisis had limited impact on Austrian 
banks.  Total write-downs were about EUR 2 billion 
until mid-2008 and actual losses so far have been only 
 
VIENNA 00001852  002 OF 004 
 
 
about EUR 200 million, according to the OeNB.  Banks 
were spared immediate fallout due to their strong 
CESEE/FSU focus, an "originate and hold" business 
model, and a focus on retail deposit business along 
with trade financing.  Austrian banks have solid 
deposit cover of their CESEE/FSU assets (i.e. loans) 
according to the OeNB.  On average, CESEE/FSU 
receivables are 112% of deposits -- versus 128% in 
Austria -- but the ratio is over 150% In Hungary, 
Latvia, Montenegro, Slovenia and Ukraine.  The 
"deposit" deficit is 61% in FSU, 27% in Bulgaria and 
Romania, 5% in the other CEE countries, and 7% in SEE. 
Austrian banks are suffering indirect effects of the 
subprime crisis, i.e., higher refinancing costs, 
declining revenues from trading and commissions, 
credit scarcity, and investor risk aversion. 
 
¶6.  In the first half of 2008 Austrian banks' 
unconsolidated -- i.e. domestic -- operating results 
were down 11.2% compared to the same period in 2007, 
stemming from lower revenues (down 1.8%) and higher 
operating expenses (up 4.0%), according to the OeNB's 
Financial Stability Report.  On a consolidated basis, 
the decline was less strong because of continued 
strong CESEE/FSU business.  So far, Austrian banks 
have been able to cover write-offs from current 
revenues and have benefited from their retail banking 
business focus.  An increase in deposits since the 
beginning of the international financial market crisis 
strengthens their liquidity position and reflects 
customer confidence in them.  However, strong profits 
in the region -- for some banks 50-80% of overall 
profits -- are over for the time being.  According to 
the OeNB, Austrian banks' consolidated profits in 2008 
will drop 25% from the 2007 level (which was an 
exceptionally good year) but still match the levels of 
2005/2006. 
 
- - - - - - - - - - - - - - - - - - - - - 
Bankers See CESEE/FSU Risks as Manageable 
- - - - - - - - - - - - - - - - - - - - - 
 
¶7.  Since the Iceland collapse -- unforeseen by rating 
agencies, Austrian banks complain -- CESEE/FSU 
countries with high external deficits have come into 
critical focus.  All Austrian banks active in 
CESEE/FSU feel that CESEE/FSU risks are limited and 
that they can continue supporting their subsidiaries, 
particularly given their strong deposit basis (with 
the possible exception of Ukraine).  However, the 
region remains under-banked and continues to offer 
long-term potential to increase financial 
intermediation.  Austrian bankers recognize that the 
boom days are over and economic growth will slow 
markedly through 2010 (see para 14 below), but say the 
region does not now face a recession and retains a 
strong medium/long-term growth potential based on 
competitive advantage and a catch-up demand for 
infrastructure.  Austrian bankers like to point to 
resiliency in emerging Europe ("this is not the first 
crisis these countries have faced") and express 
confidence that the EU, and European strategic 
investors, exert a positive stabilizing influence over 
most of the region. 
 
¶8.  Bankers here recognize the risk inherent in 
CESEE/FSU markets' dependency on capital inflows to 
finance economic growth.  Foreign banks played a role 
in that dependency with their strong lending growth. 
Rising costs of external financing and tighter 
conditions will now inhibit, rther than fuel, those 
economies.  Austrian bankes point to countries with a 
greater dependency o foreign funding (and thus higher 
risk) includin Kazakhstan, Latvia, Estonia, and 
Bulgaria, follwed after some distance by Romania, 
Lithuania andCroatia.  Another risk factor is the 
high share f foreign exchange lending (mostly in 
Euros) -- which helps Austrian banks manage currency 
risk but might call into question the credit- 
worthiness of local borrowers if a local currency 
depreciates sharply.  Countries with exchange-rate 
pegs are under special pressure:  devaluation would 
lead to payment difficulties because of the private 
sector's large foreign debts, so any expectation of 
 
VIENNA 00001852  003 OF 004 
 
 
such a development could trigger capital flight. 
Austrian banks are concerned but opine that no 
government in the region has an interest in letting 
its currency fall sharply, since all (except Russia) 
must finance current account deficits and tend to 
borrow in Euros.  (NOTE: Hungary is a partial 
exception with its forint-denominated floatings, but 
has other reasons to support the forint, say Austrian 
financial analysts - END NOTE).  Austrian banks are 
concerned about countries with high public debt 
including Hungary and much of southeast Europe. 
 
¶9.  The biggest concern is Ukraine, particularly if 
the currency volatility continues, followed by 
Hungary, Bulgaria and Romania.  For most bankers 
Russia is not a concern:  they view it as a special 
case of a country rich in natural resources.  On the 
Russian bank market, they say the worst seems to be 
over.  Since all system-relevant banks in Russia are 
owned by the government, state-owned companies or 
municipalities, the Russian government seems committed 
to help them -- and the failure of other banks would 
help promote consolidation.  For HAA, its huge 
exposure in Croatia is a problem.  In any case, 
Austrian banks remain committed to those countries and 
none is considering pulling out (though they may scale 
down in one or more countries). 
 
¶10.  Bankers express confidence that the IMF seems 
prepared to help any CESEE/FSU country in crisis and 
the EU will likely help at least the candidate 
countries.  The good news includes reforms and 
institutional deepening; moreover, the public in many 
CESEE/FSU markets now has more confidence in banks 
than in governments and political leadership. 
However, some Austrian banks says CESEE/FSU 
governments are not reacting appropriately to the 
crisis and that the banks have had to send strong 
messages that they will NOT bail out those markets 
("they're on their own" as an interlocutor put it). 
 
¶11.  Austrian regulators express strong confidence in 
their banks' ability to weather any CESEE/FSU storms 
on the horizon.  OeNB Governor Ewald Nowotny has said 
publicly that Austria will outperform other markets 
during the current crisis because of their strong 
presence in CESEE/FSU and has repeatedly predicted 
that the GOA will not have to cover losses at large 
Austrian banks.  Most bankers -- including at RI and 
EB -- echo this confident sentiment.   UniCredit CEO 
Allessandro Profumo (head of BA's parent group) has 
however expressed concern about risk -- which may 
reflect the fact that BA expanded in CESEE/FSU just 
before the crisis and may now be confronted with 
write-downs.  For example, in 2007 BA bought 95% of 
Ukrainian bank Ukrotsbank for EUR 1.5 billion:  the 
other 5% is listed on the stock exchange, where the 
share price has fallen 80% since the beginning of 
¶2008.  Also in 2007, BA bought ATF-Bank (the third 
largest bank in Kazakhstan) for EUR 1.45 billion -- in 
a market that bankers say is now quite shaky. 
 
- - - - - - - - - - - - - - - - - - - - - - - - 
IMF Stress Test:  Banks Resilient Against Shocks 
- - - - - - - - - - - - - - - - - - - - - - - - 
 
¶13.  Even though the situation has deteriorated 
considerably since the summer, a June 13 IMF stress 
test of the Austrian banking system (as part of its 
Financial Sector Assessment Program - FSAP) remains 
relevant.  (NOTE: full text available at 
www.imf.org/external/pubs/ft/scr/2008/cr08204 .pdf). 
Key messages of the IMF report are: 
 
--  The Austrian banking system shows considerable 
resilience against shocks.  Banks are well- 
capitalized, have a moderate attitude toward market 
risks, follow an "originate and hold" strategy in 
lending, and have a stable funding source in deposits. 
 
-- The main risk for the Austrian banks stems from the 
credit risks in CESEE/FSU -- but Austrian banks still 
have most assets (i.e. loans) in their domestic 
market. 
 
VIENNA 00001852  004 OF 004 
 
 
 
-- Test results of substantial strain on the banks 
showed very low or in some cases even negative return 
on equity, but capital buffers generally remained 
intact.  Severe shocks originating in CESEE and a 
global downturn causing a prolonged domestic recession 
would lead to substantial credit losses of banks and 
severely affect their return on equity.  Only in a few 
cases would the losses affect base capital, but 
capital would still remain above 8%. 
 
- - - - - - - - - - - - - - - - - - - - - - - - - 
New Economic Forecast for CESEE/FSU:  No Recession 
- - - - - - - - - - - - - - - - - - - - - - - - - 
 
¶14.  The boom is over, there will be a marked slowdown 
through 2010, but no recession in the region - these 
are the key messages of a closely-watched November 27 
forecast by the Vienna Institute for International 
Economic Studies (an independent economic research 
institute specialized in CESEE/FSU economies).  In 
individual countries -- Hungary, Estonia and Latvia -- 
a recession is likely but overall growth in the new 
EU-10 CEE member states will decline from a 6.3% 
average in 2007 to 5.0% in 2008 and 2.7% in 2009. A 
more optimistic scenario puts growth at 3.5% in 2010. 
The study predicts 2009 growth of 3% in southeast 
Europe 5.2% in Russia.  However, forecasters say their 
prognosis is especially uncertain at this turning 
point in the global economy. 
 
- - - - - - - - - - 
Comment/Assessment 
- - - - - - - - - - 
 
¶15.  While individual CESEE/FSU markets appear quite 
shaky -- and none is as broad and deep as even Austria 
-- Austrian banks still say they can manage the risks 
and potential losses, and no bank is considering a 
retreat.  The economic crisis will lead to markedly 
lower economic growth in the region, but not/not a 
region-wide recession and performance will still beat 
Western Europe, say forecasters here.  The size of the 
GoA banking rescue package gives some reassurance 
because it takes into account the Austrian banks' 
CESEE/FSU exposure.  Since all five Austrian banks 
with noteworthy CESEE/FSU subsidiaries are "system- 
relevant" in Austria -- "too big to fail" -- the GoA 
will intervene if any starts to teeter.  OeNB Governor 
Nowotny and others remain convinced that relatively 
small Kommunalkredit bank (reftels) will remain the 
only bank troubled enough to warrant GoA takeover. 
 
GIRARD-DICARLO