On January 13, 2010 the White House announced that it would levy taxes on large financial institutions (assets of above 50 bn $), in order to pay for the bailout costs of the financial crisis. Exptected are revenues of around 90 bill $ over several years. The tax base will be financial assets of financial institutions, minus insured deposits and shareholder equity. This will – relatively – benefit traditional deposit-taking banks and punish investment banks and other institutions without strong retail deposit base. This new levy is designed no only for the revenue effect, but it will also give strong incentives towards more deposit-funding instead of capital market funding of financial institutions’ balance sheets.
Enter Eastern Europe: a large part of the financing of unsustainably high Eastern European growth before the crisis came from wholesale external financing by the Western European banks which cover around 2/3 of finance in Eastern Europe (different from country to country). The financial crisis which started hitting this region at the beginning of 2009, resulted in a widespread freeze on further external financing. Partly, because the Western banks had large problems in their home countries, attempting to rebuild their balance sheets, partly they ran into problems in their host countries where businesses and households had increasing difficulties paying back the easy money loans they had received during boom times. This was exacerbated by the large share of hard-currency lending to non-hedged customers, mainly small and medium-sized enterprises and household loans (mortgages and car financing). The ensuing devaluations increased the real burden of debt to borrowers by up to 50%.
It is my (and other analysts’) assessment that wholesale external financing will not return to Eastern Europe in previous amounts. While – partly as a result of the “Vienna Initiative” and the large banking rescue packages in the West – no large-scale withdrawal of funds has occurred in the region (also, the longer-term business interests of Western banks in the catching-up process of the East, persuaded them to “stay in the region”), risk assessments, lessons learned and the problems of rebuilding their balance sheets both in the East and West will restrict capital flows from West to East in the future decades.
What does this mean for Eastern Europe? It means, first of all, that finance will be much scarcer than before the crisis, because external flows will be lower and more selective. It means, second, that as a result, GDP growth rates will be lower than before, if still higher than in the West. The consequence for finance is that local financing will have to play a much larger role, and – viz. President Ob ama – that finance will have to rely much more strongly on domestic deposits and local capital markets. This means that states will have to make stronger efforts to mobilize domestic savings. This refers to both the total amount of savings and that these savings will not be hoarded at home, but be deposited in the banks. They will also have to make much stronger efforts to reduce/eliminate capital flight.
While in the US, Obama’s scheme should lead to a revival of dodgy, non-sexy deposit-taking for banks, in Eastern Europe this is less a return, but rather a new confidence-building and savings-extolling task. A number of schemes can incentivize this requirement: incentive schemes for longer-term savings (e.g. for homeownership, for retirement); regulatory rules encouraging banks to fund their financing by deposits; building up pension funds to supplement (meagre) pay-as-you-go public pension schemes; regulating capital requirements according to deposit-base, etc.
For countries with still low financial intermediation, it is not the most sophisticated financial products which need to be developed, but rather the old-fashioned commercial bank instruments which encourage savings as a means to finance investments for growth.
This is mainly a task for national economic policy. It can and needs to be supported by the international financial institutions, such as the International Monetary Fund, the World Bank, the European Bank for Reconstruction and Development, the European Investment Bank.
The crisis has shown up the non-sustainability of the externally financed, whole/sale funding model for financial institutions. If and when the crisis is over, a more sober, more domestic-resource-oriented financing model is needed.