IMF, EBRD urge Eastern Europe banks to recognise losses

Banks operating in emerging Europe may have been too slow in recognising possible losses due to bad debt and could face a day of reckoning early next year, international financial institutions warned on Tuesday. The former Communist region's banks, most under western ownership, have used leeway in local accounting rules to build up reserves for bad debt as slowly as possible this year, and as a result only few of them are expected to report losses.

But this may have come at the price of keeping loans to borrowers alive that are not viable in the long term, International Monetary Fund (IMF) Senior Adviser Christoph Rosenberg told a conference in Vienna. The biggest lenders in emerging Europe are Italy's UniCredit , Austria's Raiffeisen International and Erste Group Bank, Societe Generale, Belgium's KBC and Hungary's OTP. 'The suspicion is that banks are 'evergreening' loans,' Rosenberg told the conference hosted by the Austrian central bank. 'We are closely watching that development.' Rosenberg said that this practice was boosting profits this year, but that it may run out of steam at some point.

'In the long run, it doesn't serve the interests of the financial sector to carry unviable banks or corporates,' Rosenberg said, reiterating the IMF's concern that corporate refinancing risks were still very high in emerging Europe. The European Bank for Reconstruction and Development's (EBRD) Chief Economist Erik Berglof said that delaying the build-up of both non-performing loans and of the reserves set aside to cover them was particularly pronounced in Ukraine. 'The country that illustrates best the lack of recognition is Ukraine where all the banks have been 'evergreening' credit,' Berglof told reporters on the sidelines of the conference.

'That will come back to reckoning at the beginning of next year,' Berglof said. Ukraine, whose economy is on track to shrink by 15 percent this year, has one of the highest levels of bad debt in Europe with about 30 percent of all loans impaired at the end of the second quarter. The banks' strategy to go easy on building reserves has allowed them to safeguard profits and avoid massive dilutive cash calls at depressed prices earlier this year. But having run down the ratio of reserves to non-performing loans to as low as 50 to 60 percent -from close to or more than 100 percent going into the crisis - there is little room left to manoeuvre. The main risks are that loans that were restructured to avoid default become non-performing anyway, that collateral seized proves to be worth less than thought, and that rising unemployment and corporate insolvencies create more bad debt.

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