The FINANCIAL — The FINANCIAL interviewed Thomas Lubeck, Regional Head of IFC in the Caucasus. Mr. Lubeck thinks that the banks in the Caucasus are some of the best banks in Eastern Europe. But he says that “even if the best happens, 80% growth in lending in Georgia and Armenia will not come back anytime soon.”
International Finance Corporation (IFC) is helping banks in Georgia and Armenia mitigate risks and strengthen their ability to continue lending to local entrepreneurs and small businesses during the global financial and economic crises. The FINANCIAL interviewed Thomas Lubeck, Regional Head of IFC in the Caucasus. Mr. Lubeck thinks that the banks in the Caucasus are some of the best banks in Eastern Europe. But he says that “even if the best happens, 80% growth in lending in Georgia and Armenia will not come back anytime soon.”
Q. What will your main advice be for banks, how might they manage to shorten risks against the background of the financial and economical crisis?
A. I think that most banks already understand that they need to have liquidity available to repay any cross border loans that they have borrowed. In addition, banks have been raising capital in order to have a cushion against increasing levels of non-performing loans. IFC has been focusing its investments in Georgia and Armenia to help the banks with both of these issues. It is also critical for banks to find ways to increase the amount of deposits that they are raising from the population. Over the long run, this will prove to be the most stable and reliable source of funding.
Q. The event managed by IFC and entitled “Weathering the Storm” brought together executives and managers of leading financial institutions and representatives of financial regulators to discuss lessons learned from previous financial crises and strategies for dealing with the current crises. Can you tell us more concretely, what were the lessons and which economical institutions should have learnt from previous crises?
A. The first part of the seminar dealt with case studies on the origins of the current global financial crisis as well as case studies on the problems faced by the banking sectors in Turkey and Argentina earlier this decade. A major lesson coming from both cases was the need to prudently manage exchange rate and interest rate risk. The second part of the seminar was given by two senior members of IFC’s own problem loans department. They provided specific advice to the participants on their experiences in resolving problematic corporate loans as well as how to design departments within banks that will deal with problematic loans and investments.
Q. Taking into account past lessons, was it possible to prevent the economical crisis?
A. The root cause of this financial crisis was imprudent lending on the part of banks in the United States to individual mortgage borrowers that did not have the income to properly service the loans. The banks did this because real estate prices were increasing rapidly and US banks were able to sell these risky loans to other banks or institutions that would bundle them together and sell asset backed securities to other financial institutions around the world. Once these initial mortgage borrowers started to default, losses started appearing in the financial institutions all around the world which had bought the asset backed securities. Because the risk was spread globally, no-one really knew where the losses would appear and how large they would be. This, in turn, caused a crisis of confidence that affected the entire international financial system.
Taking all of this into account, the simple lessons for banks are to always undertake prudent underwriting of mortgage loans (or any other loans), always remember that real estate and other asset prices cannot increase in price forever and understand what you invest in. I question whether many of the big financial institutions really understood the risks in the highly complex asset backed securities they purchased.
Q. The crisis has overwhelmed lots of the largest banks, while small banks have managed to survive. What was the reason for this?
A. The largest financial institutions in the world, including banks and insurance companies, were involved in very complex activities such as dealing in mortgage backed securities and derivatives created from so called “subprime mortgage loans” and buying and selling credit default swaps. Although the large banks had very sophisticated risk management systems, when things started to go wrong they were unable to put proper valuations on their complex investments. This explains why there were continuous announcements of increasing losses at specific banks and multiple injections of capital from governments.
We still do not know whether losses of the largest banks, insurance companies and hedge funds have been fully identified and disclosed.
The small banks that have performed better during the crisis tended to focus on basic banking activities such as taking deposits and granting loans, which provide a steadier source of income. These small banks usually kept to their local markets and understood better the risks that they were taking.
Each individual bank has its own specific situation and needs. However, some of the risks in the Georgian and Armenian banking systems are the same, including foreign exchange risk, credit risk, particularly to the real estate and construction sectors which are under pressure, and maintaining a stable customer deposit base. Fortunately for both Georgia and Armenia, the banks were really focused on the basic granting of loans and taking of deposits – both markets still have a lot of untapped potential in both areas.
Q. The seminar is focused on handling situations with borrowers who face difficulties while repaying loans. In Georgia customers responsible towards banks are complaining about using forced methods. What is the best way for handling the situation between the banks and their borrowers?
A. First we require all financial institutions that IFC works with to always abide by the local laws of the country and only use legal methods to pursue non-paying borrowers. Second, I think that most banks realize that using “forced” methods to get repayment from clients is ultimately unproductive because it damages their image and discourages their customer bases longer term.
If a customer is not repaying a loan because they are facing temporary financial difficulties, the best idea is to be open with the bank and explain the situation.
I think that the customer will find the banks willing to work with them to find a way to restructure the loans so that the loans can ultimately be repaid without killing the borrower.
However, if the borrower has the resources available but is intentionally not repaying the agreed loans, then this is a question of dishonesty and lack of integrity. I would expect that the banks would vigorously try to enforce their legal rights to repayment. Such borrowers should understand that this strategy will ruin their reputation and irreparably damage their ability to get any financing in the future.
Q. The world economical crisis made most banks to increase interest rates on loans. Do you consider this step as a way to prevent the current difficulties and by how many percentages do you advise Georgian banks to increase interest rates?
A. The interest rates are set by supply and demand and can go up and down. When I first started working in banking in Georgia in 1999, some corporate clients were paying up to 36% on short term USD loans. Even in the crisis scenario today no one would consider paying this much. Georgia and Armenia have competitive banking systems which have ensured over the long term that clients are getting better quality products at cheaper prices. The spike in interest rates in my view will go down over time as the situation settles.
We encourage banks to continue lending to good customers. However, in the short term, there is sure to be reduced lending activity because the banks are now focusing on maintaining the quality of their loan portfolios, rather than rapidly increasing them. The days of 80% growth in lending in Georgia and Armenia will not come back anytime soon.
What I hope will happen in many countries in Eastern Europe is that dependence on foreign capital to finance the growth of the banking system and economy will be mitigated by the creation of local financial markets. The development of more retail bank deposits and a local investor base among banks, insurance companies and pension funds would reduce the risks of refinancing and currency risks borrowers face from taking hard currency loans from abroad. This goal will be more difficult to achieve in some countries than others because of the level of income and savings, but increased local participation in the financial system is critical in my opinion to mitigate future crises.
Written By Madona Gasanova
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