One major concern for Romania is that foreign banks present on the local market will use funds available for lending to increase capitalization in their headquarters. The Romanian officials assure us that at their request the EU leaders agreed to “regulate these capital flows”. It is not the first time we would see capital controls introduced in the region. The first instance was in the spring of 2009 when Banks operating in the CEE region “agreed” to keeping a certain level of funding their assets. It did not work very well as banks kept the exposure but did not credit the private economy.
This time around Romanian officials and IMF officials fall over each other in declarations that the deal reached last week guarantees that the banking sector will continue in the region in the current form regardless of their needs at home. As I said before: I doubt it. But I went back to the statement from the EU Council. I cannot find any clear guarantee that need for capital will not lead to reducing business in CEE countries by some banks.
In fact, here is what the official statement says (highlights are my own):
National supervisory authorities, under the auspices of the EBA, must ensure that banks’ plans to strengthen capital do not lead to excessive deleveraging, including maintaining the credit flow to the real economy and taking into account current exposure levels of the group including their subsidiaries in all Member States, cognisant of the need to avoid undue pressure on credit extension in host countries or on sovereign debt markets.
As you can see the statement says that it is desirable that banks capitalization does not lead to excessive deleveraging. In plain language this means that banks can reduce exposure but should be done in orderly fashion. Of course it advises that the deleveraging plans do not put “undue pressure” on host countries. Which actually means that while “deleveraging” some banks might have to sell government bonds from the host countries to raise capital. When they do this banks should try and do it “smoothly” in order not to create too much volatility. In fact selling assets or restructuring the business in order to raise capital is recommended by the EU Council.
And these are the details put forward by in the statement form the EU Council regarding bank’s capitalization:
Banks should first use private sources of capital, including through restructuring and conversion of debt to equity instruments.
To me “private sources of capital” and “restructuring” spell deleveraging from countries where capital is kept idle and the risk premium is high.One of those countries is Romania.
There is another way however, to keep capital in Romania, and even to add some extra. If Romanian policy makers believe that it is in the country’s interest to keep the current business of the foreign banks present here than they should consider a market aproach to the problem:
-create an economic environment that supports growth. Austerity measures alone will lower growth and thus further depress private investment and consumption.
-do much much more to lower the risk perception about Romania. Putting forwards lower budget deficit figures while not paying your bills to the private sector does not induce trust. Lack of vision regarding budget revenues while you still own important parts of the economy, and two banks (?!), undermines the message that Romania is a market economy managed by professionals.
-lower taxes for capital. If the government is really serious about keeping/adding foreign capital in Romania than it should tax it lower. This is the most direct way to increase the return on capital.
These market solutions have worked in the past even for Romania (e.g. flat tax). Not to mention that they are cheaper as they do not require more public workers monitoring the bank’s exposure to the market.