2015: A transition year

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1 CEE Banking Sector Report June : A transition year Upside on some CE/SEE markets Restructuring in HU and RO well advanced NPL improvements in CE/SEE, downside in EE 214 RoE in CEE at 6%, not much upside for Please note the risk notifications and explanations at the end of this document 1 IMPORTANT NOTICE: NOT FOR DISTRIBUTION TO ANY US PERSON OR TO ANY PERSON OR ADDRESS IN THE US

2 Content Table of contents Executive Summary 3 Definition of subregions, economic overview 5 Banking trends in CEE Ownership structures and market concentration 6 Focus on Russia: Harsh market and political trends to impact competitive landscape 8 Financial intermediation, asset-to-gdp ratios 9 Focus: Deleveraging debate in CEE banking 11 Loan growth, growth by segments (retail, corporate) 12 Funding, deposit growth and L/D ratios 14 Profitability (Return on Assets, Return on Equity) 16 Focus: Non-performing loans and NPL ratios 17 CEE banking growth and overall market outlook 19 Country Overviews Poland 22 Hungary 24 Focus: A big-picture view on Hungarian banking 26 Czech Republic 3 Slovakia 32 Slovenia 34 Croatia 36 Romania 38 Bulgaria 4 Serbia 42 Bosnia and Herzegovina 44 Albania 46 Russia 48 Ukraine 5 Belarus 52 Focus on Ukraine: Key provisions of IMF program 54 Market players in CEE 55 Appendix: Key CEE banking sector data 81 Key abbreviations 82 Risk notifications and explanations 84 Disclaimer 86 2 Please note the risk notifications and explanations at the end of this document

3 Executive Summary Executive Summary CE/SEE: New lending cycle may start; balance sheet clean-up results in improved NPLs, but affects profitability EE: Western banks may start to rethink their market presence, returning to boutique-style business models High-growth markets: Poland, the Czech Republic, Slovakia, Hungary and Romania Dear reader of the CEE Banking Sector Report 215! The year 214 marked the 25 th anniversary of the fall of the Iron Curtain a historic event that laid the foundations for a success story in terms of economic development and political stability on the European continent. Yet, the celebrations were rather moderate, as 214 turned out to be quite challenging for the EU and Central and Eastern Europe (CEE) economically and politically. For one, 214 was characterized by great uncertainty stemming from the political tensions in the EE region. While the Ukrainian economy and banking sector saw a terrible year, Russia was still able to absorb the negative impacts from the economic nosedive, RUB collapse and Western sanctions. For 215, we expect a deterioration of key economic indicators with negative impacts gradually feeding into the banking sector performance. Moreover, the medium-term economic and banking sector outlook for Russia seems less favorable than anticipated some years ago. Hence, the largest foreign-owned banks may overthink their presence in Russia and consider more cautious business models, while stateowned banks might even increase their market share. Up until 216, we currently do not see a significant improvement of the economic situation in EE. It will take extensive structural reforms to recover and to return to somewhat sustainable growth patterns. Also, only time will show if the current IMF program for Ukraine will be sufficient to make up for the structural and economic damage caused over the past months of armed conflict and political challenges. Given the significance of EE for the entire CEE region, we dedicated a focus on both Russia (page 8) and Ukraine (page 54) to take a closer look on the current situation and to give a near-term outlook on the development of these two banking sectors. Real GDP (% yoy) e 215f 216f CE/SEE EE Euro area Source: national sources, Eurostat, RBI/Raiffeisen RESEARCH Cross-border claims* The second major topic in 214 in European banking was the Asset Quality Review (AQR) and stress testing by the European Central Bank (ECB) and the European Banking Authority (EBA). The results were stricter regulations and requirements for the entire European banking industry and a broad-based balance sheet clean-up. CEE banking markets were also affected, as Western CEE banks had to adapt their business models and overall market presence. On a positive note, this process led to improved NPL ratios in CE/SEE and more risk-averse lending policies. At the same time, stricter capital requirements and increasingly negative effects stemming from the ultra-low interest rates environment resulted in profitability pressure in several key CE banking markets. Overall, the appeal of CE/ SEE banking markets, with the exception of Poland, the Czech Republic and possibly Slovakia, suffered compared to the euro area. Hence, our focus on the Deleveraging debate (page 11) discusses the current dilemma of Western banks in CEE. 5 Dec 7 Mar 1 Jun 12 Sep 14 CE/SEE EE Euro area * BIS-reporting Western European banks (Dec 27 = 1, latest data point Q4 214) Source: BIS, RBI/Raiffeisen RESEARCH Please note the risk notifications and explanations at the end of this document 3

4 Executive Summary CEE: RoE & impact on foreign banks* (1) 1 (4) 11 (4) 12 (3) 13 (1) 14 (3) CEE RoE (right hand scale) Impact on foreign banks** * RoE and average market share loss-making CEE banking markets in %, loss-making in 214: Hungary, Romania, Ukraine ** Average market share foreign-owned banks on lossmaking CEE markets, number of loss-making markets - if any - in brackets on horizontal axis Source: national central banks, RBI/Raiffeisen RESEARCH CEE vs. EA profitability (RoE, %) CEE Euro area Long-term avg.* Max Min 214 * Source: national central banks, ECB, RBI/Raiffeisen RESEARCH 8 4 With regards to the growth outlook for the individual CEE banking markets, we continue to consider Poland, the Czech Republic and Slovakia as high-growth markets, characterized by modest levels of financial intermediation and hence a fair chance that lending and asset growth can outpace GDP growth on a sustained basis. From a fundamental perspective, the turnaround markets of Hungary and Romania may be added to this group of countries. Both banking markets did see an economic and banking sector turnaround in recent years (based on deleveraging, harsh one-off losses and NPL restructuring). However, at this point it is difficult to predict if the restructuring of the past few years has been yet sufficient to start a decent upturn already in 215. Our country pages (page 22) provide a detailed picture of individual CEE banking sectors. A special section (page 26) covers the long-term trends in Hungarian banking. Following harsh adjustment in recent years, we may see a return to growth and profitability based on a more constructive stance by Hungarian policymakers. In retrospective, 214 was much more challenging than expected. Economic growth in the euro area was disappointing, and the stricter regulations on the banking sector resulted in a new reality for the European banking industry as a whole. In addition, the political tensions in the EE subregion worried businesses and investors. In total, three out of 14 CEE banking markets (Hungary, Romania and Ukraine) were loss making in 214, which is close to the number of loss making markets (four) seen in the aftermath of the global financial crisis in 28/9. The Russian banking market experienced a noticeable drop in profitability in 214 (RoE down from 15% to around 8% in 214, Q1 215 RoE at 4.8%). For 215, we expect cautious and very selective business strategies of larger Western European CEE banks, characterized by capital discipline as well as a stark differentiation between country and business segment strategies. Therefore, overall business strategies in CEE banking are likely to be dominated by balance sheet optimization, cost-cutting, very selective growth and investments strategies focusing on product optimization, modernization and operational efficiency. It is unlikely that we will see new market entries or large-scale expansions of existing branch networks. Although we still expect 215 to be a transition year in CEE banking, we see players that are already positioned to profit from the increasing upside and next credit cycle in CE/SEE banking and who are placed to gain market share and to lay the foundations for future growth and profitability. The overview on individual market players (page 55) discusses the business models and strategies of the largest Western and Russian banks operating in the CEE region and offers data for comparison. We hope you find the CEE Banking Sector Report 215, with our analysis, data and graphics in it, a reliable and unique reference for your daily work. On behalf of the author team, Gunter Deuber Elena Romanova Vienna, June Please note the risk notifications and explanations at the end of this document

5 Subregions and economic overview CEE: GDP per capita (in % of European Union average)* Central Europe (CE) Eastern Europe (EE) 1 CZ HU PL SK SI AL BH BG HR RO RS BY RU UA f * at PPP; f: IMF forecasts Source: IMF WEO, RBI/Raiffeisen RESEARCH Key economic indicators Real GDP (%yoy) GDP (EUR bn) Southeastern Europe (SEE) Trade (% of GDP) Public debt (% of GDP) Unemployment (%) f Chg. (14-18f vs. -13) Poland Hungary Czech Republic Slovakia Slovenia CE Croatia Romania Bulgaria Serbia Bosnia and Herzegovina Albania SEE Russia , Ukraine Belarus EE , Euro area , Source: national sources, Eurostat, RBI/Raiffeisen RESEARCH Key institutional indicators Ease of Doing Business Rank* Getting Credit* Enforcing Contracts* Resolving Insolvency* Corruption Perception Index** Poland (EU) Hungary (EU) Czech Republic (EU) Slovakia (EU/EA) Slovenia (EU/EA) CE (avg.)*** Croatia (EU) Romania (EU) Bulgaria (EU) Serbia Bosnia and Herzegovina Albania SEE (avg.)*** Russia Ukraine Belarus EE (avg.)*** * out of 189 countries, ** out of 175 countries, *** regional aggregates unweighted averages Source: World Bank, Transparency International, RBI/Raiffeisen RESEARCH Key banking indicators Bank assets (EUR bn, 214) Assetsto-GDP (2) Assetsto-GDP (214) PL 36 61% 89% HU 12 67% 1% CZ % 126% SK 63 89% 81% SI 37 71% 1% CE % 98% HR 53 63% 123% RO 9 29% 61% BG 28 36% 14% RS 27 53% 85% BH 13 36% 92% AL % 98% SEE % 81% RU 1,136 32% 19% UA 68 23% 86% BY 33 28% 62% EE 1,238 31% 16% Source: national central banks, RBI/Raiffeisen RESEARCH Please note the risk notifications and explanations at the end of this document 5

6 Banking trends in CEE Ownership structures and market concentration CEE: Presence of state-owned banks* CEE: Number of banks operating CE SEE EE (r.h.s.) * in % of total assets Source: national central banks, RBI/Raiffeisen RESEARCH 1,6 1,5 1,4 1,3 1,2 1,1 1, CE SEE EE (r.h.s.) Source: national central banks, RBI/Raiffeisen RESEARCH In the CE banking sectors, the secular trend of gradually decreasing foreign ownership ratios continued in 214. For the first time in over 15 years, the foreignownership share dropped slightly below 7% of total assets. This decreasing share reflects a market-based gradual decrease of foreign ownership in Poland, a state-led restructuring of ownership in Hungary as well as state-driven bank bailouts in Slovenia. In SEE, the foreign ownership ratio remained at a high level of around 8%, with a slight upward bias from 212 to 214. Minor decreases in the foreign ownership ratio in Croatia and Romania were overcompensated by a fairly strong rise in Bulgaria by some 5 pp, which was the result of the failure of one fast growing local player. Hence, a modest correction in the SEE foreign ownership ratio could be in the cards for 215/16. In the EE countries, foreign ownership ratios are characterized by two very divergent trends. In Russia, the market share of 1% foreign-owned banks has been decreasing ever since 28. The 1% foreign ownership ratio in the Russian banking sector currently stands at 7.6%, the 5% foreign ownership ratio (which includes lenders with foreign participation and partially also Russian offshore-money) stands at some 14%. Compared to Russia, the market share of foreign-owned banks in Ukraine was on an uptrend in 214, increasing from 27% to around 31%. However, this market share increase should not be overrated. It is by and large a reflection of an increasing number of failed and restructured locally-owned banks, while foreign-owned players (among the largest banks) are still in the market. The overall foreign ownership ratio in the EE banking sector remains below 1%, showing that foreign-owned banks in EE are niche players compared to their presence in the CE/SEE region. Not much has changed with regards to state ownership ratios in nearly all CEE banking sectors, with the possible exception of Hungary. There, state ownership increased from some 6% in 213 to around 12% in 214. The overall state ownership in the CE region remains more stable at around 15%, mainly driven by Poland, Hungary and Slovenia (as state ownership is insignificant in the Czech and Slovak banking sector). In SEE, state ownership remains insignificant in all banking sectors, with the exception of Serbia where it stands at some 2%. With re- CEE: Presence of foreign-owned banks (% of total assets) 9 22 CEE: Average bank size (EUR bn)* CE SEE EE * Total assets divided by number of banks Source: national central banks, RBI/Raiffeisen RESEARCH Central Europe Southeastern Europe EE (5% foreign-owned Russian banks, r.h.s.) EE (1% foreign-owned Russian banks, r.h.s.) Source: national central banks, RBI/Raiffeisen RESEARCH Please note the risk notifications and explanations at the end of this document

7 Banking trends in CEE gards to potential changes in state ownership, we may see a sale of state assets in Hungary and Serbia going forward. In the EE region, state ownership in the banking sector remains significant, with an uptrend in recent years mainly driven by Russia, with a 55% share in 214 and potential for further increases. The Russian Central Bank (CBR) expects the market share of state-owned banks to increase above 6% in the years ahead. Moreover, the de facto influence in the banking sector is even higher (and increasing) compared to the official ownership figures (see also our focus section on page 8). The banking sector in Ukraine also experienced an increase in state ownership in 214, while there was a further modest decrease in the state ownership ratio from very high levels in Belarus. Given the high fragmentation of the Russian and Ukrainian banking market, the challenges of 214 resulted as expected in an increased number of market exits and overall market consolidation. This trend comes as no surprise and is expected to continue in 215. In Russia, the number of banks dropped from 923 to 834, which reflects one of the highest reductions in over a decade. However, this high number of market exits did not impact the market concentration, as the exiting banks were quite small. The market share of the Top 5 banks in Russia remained more or less flat at around 55%. In all other CEE banking markets there was not much change in terms of the number of banks and market concentration. In Ukraine, the high number of market exits (17 in 214 and at least 1 to 15 more as of May 215) may finally result in an improvement of overall market standards and practices. As a result, the market share of the Top 5 banks increased to 43% in 214 (up from the mid-3ies), which still leaves room for further structural consolidations. On the Russian market, the increasing de facto and de jure state ownership may partially compensate for the positive effects of a decreasing number of market players (in some cases with non-viable business models). Over the past years, the number of banks in CE stayed quite stable with 2 banks, while SEE continued to see a modest drop. Here, some 2 banks left the region in the past five to six years. However, as the SEE banking market is comparably small (total assets at some EUR 2 bn vs. EUR 75 bn in CE banking markets), the currently 17 banks operating in it still suggest more room for consolidation. That said, the overall profitability and margin pressure in CE and SEE (including core markets like Poland, Hungary and Romania) makes further consolidations in both regions likely. The Top 5 concentration in CE remains more or less constant at around 6%, with higher concentrations on the Czech and Slovak markets, but below average market shares in Hungary and Poland. While the Top 5 concentration in Hungary is further decreasing, it is on the rise in Poland. Although this increasing concentration in Poland (driven by organic growth and M&A) is positive for the market, it also implies that further players may reconsider their presence on this consolidating market. On average, the Top 5 concentration in SEE remains a tad lower than in CE. However, this ratio is largely driven by a fairly low market concentration in Romania, Serbia and Bulgaria, while in other SEE markets the market share of the Top 5 banks is much higher. We expect further consolidation (in terms of market shares) in SEE to be concentrated in Romania and Serbia either in terms of organic growth or M&A. EE: Average bank size (EUR bn)* EE Russia Russia (excl. Sberbank, VTB) Ukraine * Total assets divided by number of banks Source: national central banks, RBI/Raiffeisen RESEARCH RU: Ownership & concentration (%)* Market share state-owned banks Market share Top 5 banks * in % of total assets Source: CBR, RBI/Raiffeisen RESEARCH CEE: Avg. market share Top 5 banks* CE SEE EE * in % of total assets Source: national central banks, RBI/Raiffeisen RESEARCH Financial analysts: Gunter Deuber, Elena Romanova, RBI Vienna Please note the risk notifications and explanations at the end of this document 7

8 Banking trends in CEE Focus on Russia: Harsh market and political trends to impact competitive landscape 214 was a challenging year for Russia, as its banking sector had to digest and adjust to multiple changes that also impacted its competitive landscape. Several trends in the sector s composition intensified, and some new tendencies revealed their initiations. Following, we will focus on three main trends: Sector concentration is set to increase, with the share of state-controlled banks boosting Foreign banks are set to contract on cautious risk taking Total overall number of banks is expected to progressively diminish We start from the latter. The banking sector clean-up continued. Both, the CBR-initiated foreclosure of feeble banks as well as the impact of deteriorating economic and market conditions, which intensified further crowding-out of inefficient bank-like institutions, led to a notable reduction of the number of banks. In 214, it contracted by about 1% yoy to 834. We see this development as positive and long needed for the sector improvement, and expect the number of banks to further decline, albeit perhaps at a bit lower speed. Besides, along with the decreasing fragmentation of the Russian banking sector, there comes an increasing concentration within the remaining banking cohort. We expect state banks market share to increase further Although on balance, the share in total assets of state-controlled banks stayed stable at 55% in 214, we expect it to grow towards 6% in the course of the next couple of years. The current financial market turmoil, and the expected economic nosedive in 215/16, should benefit state-controlled banks market positions both on funding and lending sides. On the funding side, first, state-controlled banks are still considered safe havens and places for the retail savings to wait until the market calms down again. Second, amidst the volatility of interest rates, these banks are able to offer the most attractive deposit pricing to private deposit holders. Also, as the government started to talk about re-thinking the volumes and rules for state guarantees on commercial banks deposits, risk-averse households are likely to shift their funds to state-controlled banks, too. On the lending side, these banks are the first choice for the government to distribute stabilization loans and other financial support to distressed systemic borrowers. In retail business, the recent state measures to support the mortgage lending (interest rates subsidizing, issuing loans to low-income categories of population, etc.) are also by and large introduced via state-controlled banks. The fact that funding and recapitalization of these banks also benefit from the governmental support, makes it easier for them to maintain and even increase their asset size and market shares. In addition, the role of sizeable regional banks that are controlled by the regional authorities must not be discounted. Even though their relative size is much smaller (below 1% of total banking assets for each), and their individual impact on the Russian economy is much less notable than that of the Top 5 players, these regional players role gains increasing importance in supporting the regional economies. Foreign banks: Contracting lending and presence It seems that for the first time in over a decade, foreign banks are losing their optimism regarding the development of the Russian banking market. Even though the market still suggests potential for returns, the nature of emerged counterweighting risks makes it currently difficult and costly to manage the risk-return tradeoff. In addition, Western sanctions crowd out a significant share of corporate customers from foreign banks franchises, and respectively, all sorts of related business. RU: Market shares (% of total assets) 6% 5% 4% 3% 2% 1% 12% 1% 8% 6% 4% % 2% State-owned banks Foreign-owned banks (r.h.s.)* * 1% foreign ownership ratio Source: CBR, RBI/Raiffeisen RESEARCH Therefore, foreign banks, which kept their presence in Russia after the 28/9 crisis, have started to act towards de-risking in Russia. Whether accompanied by publicly declared programs, or just organically implemented on a routine basis, we expect the balance sheet contraction (in EUR-terms) of Russian subsidiaries of the major foreign banks to be notable. Like for all processes linked to political risks, the scope of this expected contraction is hard to predict precisely. However, if today s trends in geopolitics stay approximately unchanged, without sudden significant worsening or improvement in the shortterm perspective, we see a possibility for foreign banks share in total banking assets to go down closer to 5%, which are the levels seen back in 22/3, within the next two to three years. Nevertheless, such a scenario would imply that Western foreign-owned lenders would still have a combined asset base of some EUR 5 bn to 6 bn on the Russian market, while Russian assets of major foreign-owned banks stood at some EUR 5 bn to 1 bn some ten years ago. Financial analyst: Elena Romanova, RBI Vienna 8 Please note the risk notifications and explanations at the end of this document

9 Banking trends in CEE Financial intermediation levels, asset-to-gdp ratios Overall financial intermediation in CEE as measured by asset-to-gdp ratios increased from some 89% in 213 to well above 1% in 214. Hence, this ratio reached an all time high, posting one of the strongest increases (in pp) over the past 15 years. Such a surge is definitely somewhat surprising, given the still ongoing deleveraging in several key CEE economies, the subdued or just modestly recovering GDP growth and moderate loan demand in numerous countries of the region. However, there were stark distorting effects at play that inflated the overall CEE financial intermediation level in 214. Due to massive currency devaluation effects in the EE region (including the heavyweight Russia), tangible shares of assets in FCY as well as negative developments for the denominator (GDP), the increase of the 214 asset-to-gdp ratio in EE was stronger than the real asset growth. Moreover, Russian asset growth was also driven by other distorting effects, namely the strong banking sector expansion in the first half and state support to banks and corporates in the second half of 214 (which supported strong corporate loan growth). The average asset-to-gdp ratio in CE continues to remain more or less constant at around 98% a level that has not changed much since 28/9. For the SEE region, the year 214 was again characterized by another drop of the asset-to-gdp ratio, down by 2 pp to 8% in 214 about 6 pp below its peak in 21. The relative stability in the CE asset-to-gdp ratio masks stark and fundamentally backed intra-regional divergences, while the ratio s downward trend in SEE is more broad-based. In CE, the financial intermediation trends continue to remain more positive in Poland, the Czech Republic and Slovakia, while in recent years substantial drops in the asset-to-gdp ratio (by around 3 pp) in Hungary and Slovenia were driven by decisive deleveraging and restructuring (including write-offs). The sustained and more broad-based pressure on the asset-to-gdp ratio in SEE, which was seen over the past few years, is well in line with our longheld view that some deleveraging was needed (and in some cases still is) following the brisk financial sector expansion that took place between the years 2 and 28/9. CEE: Asset-to-GDP ratios 11% 95% 8% 65% 5% 35% 2% CE SEE EE Source: national central banks, RBI/Raiffeisen RESEARCH CEE vs. EA: Total asset growth (% yoy) 35% 3% 25% 2% 15% 1% 5% % -5% -1% CEE* Euro area * EUR-based Source: national central banks, ECB, RBI/Raiffeisen RESEARCH CEE vs. EA: Long-term asset-to-gdp ratio trends 11% 1% 9% 8% 7% 6% 5% 4% 3% % 28% 26% 24% 22% 2% 18% CEE vs. EA: Asset-to-GDP catch-up 1% 1.4% 8% 1.%.6% 6%.2% 4% -.2% -.6% 2% -1.% % -1.4% CEE total assets (% of euro area) Change vs. euro area (pp, r.h.s.) Source: national central banks, ECB, RBI/Raiffeisen RESEARCH CEE total assets (% of GDP) Euro area total assets (% of GDP, r.h.s.)* * Excluding MFI-business Source: national central banks, ECB, RBI/Raiffeisen RESEARCH Please note the risk notifications and explanations at the end of this document 9

10 Banking trends in CEE Change total assets (EUR bn) Cross-border claims* , CEE* Euro area * EUR-based Source: national central banks, ECB, RBI/Raiffeisen RESEARCH 5 Dec 7 Mar 1 Jun 12 Sep 14 CE SEE RU TR EA * BIS-reporting Western European banks (Dec 27 = 1, latest data point Q4 214) Source: BIS, RBI/Raiffeisen RESEARCH In Hungary, Slovenia and Romania where the deleveraging process lasted at least half the time of the boom phase most of the much needed deleveraging has already been achieved or is likely to be achieved in 215. Interestingly, the strongest deleveraging took place in Romania the one SEE country with possibly the least deleveraging needs from a fundamental point of view. Going forward, we see a chance that the asset-to-gdp ratio in CE continues its modest uptrend. In contrast, we do not see much near-term upside for the asset-to-gdp ratio in SEE. Although we see the Romanian banking sector ready for a new lending cycle, improvements in countries like Croatia and Serbia are still to come. With the recent surge in asset-to-gdp ratios in Russia and Ukraine, both countries are characterized by financial intermediation levels close to or even above thresholds that could be deemed as fundamentally backed and sound. A comparison of the wealth and financial intermediation levels with CE/SEE peers illustrates this quite well. Russia s GDP per capita level currently remains some 25 pp below the one in CE, while its asset-to-gdp ratio (currently at some 11% of GDP) is about 11 pp above CE levels. A comparison to the still more leveraged SEE region is even clearer. On the one hand, GDP per capita levels in Russia are some 12 pp above the ones in SEE. On the other hand, Russia s asset-to- GDP ratio is now some 36 pp above SEE levels. Although overall financial markets in Russia are fairly sophisticated from a regional perspective, which usually adds to a certain upward bias in the asset-to-gdp ratio, it seems that there is not much fundamental underpenetration left on Russia s banking sector. Therefore, the times of fairly easy catching-up asset growth (with asset growth strongly outpacing GDP growth) without risks of accumulating too much threats to asset quality seems to be over. Hence and for the time being, Russia s banking sector cannot be considered as a high-growth market from a fundamental point of view, i.e. unless wealth levels and nominal GDP levels are again increasing very strongly a scenario that we do not foresee for at least the next one to two years. The increasing leverage of the Russian economy during the recent years of weaker economic expansion implies that the (retail) credit-driven growth model runs out of steam just like the economy s strong dependence on oil price growth. This development adds to our more cautious medium-term economic and banking sector growth outlook. In Ukraine, the fundamental degree of overleverage is extreme. As one of the poorest countries in CEE, Ukraine has one of the highest asset-to- GDP ratios in the region at some 8% to 9%. While in Russia, we might only see a period of just a flat asset-to-gdp ratio, in Ukraine a substantial reduction, similar to the one between 29 and 212, seems likely for the years ahead. This process will be supported by the massive banking restructuring as well as substantial write-offs (page 54). Cross-border claims* Dec 7 Mar 1 Jun 12 Sep 14 Czech Republic Romania Croatia Poland * BIS-reporting Western European banks (Dec 27 = 1, latest data point Q4 214) Source: BIS, RBI/Raiffeisen RESEARCH The current real growth picture in CEE banking seems to be better represented in the overall total asset base of the region. Due to somewhat improving banking dynamics inside the euro area, still ongoing deleveraging in some CEE banking markets, modest currency weakness in several CE/SEE markets as well as strong currency depreciation in EE, the overall CEE banking asset base decreased in 214 in absolute EUR-terms as well as in relative terms (e.g. in relation to the euro area). Total CEE banking assets dropped from EUR 2.4 bn to around EUR 2.2 bn in 214. Given slightly increasing banking assets inside the euro area the first increase in nominal terms since 211 overall CEE banking assets dropped from 9.7% of euro area banking assets to 8.6% in 214 (marking one of the strongest relative drops in recent years). That said, it seems that the (Western) European large-scale rebalancing and deleveraging cycle at least in terms of total banking assets is gradually drying up, while the CEE banking sector was underperforming compared to broader European banking trends in 214. Financial analyst: Gunter Deuber, RBI Vienna 1 Please note the risk notifications and explanations at the end of this document

11 Banking trends in CEE Focus: Deleveraging debate in CEE banking Cross-border financing and the (potential) deleveraging of Western banks in CEE continues to be a widely followed topic. Its relevance has even increased once again as new aspects in the so-called Deleveraging debate arose. By and large, there was nothing like an aggressive deleveraging of Western banks in CEE up to now, although the region exhibits one of the most impressive penetrations by foreign (cross-border) banks among Western and global emerging market banking sectors. Currently, cross-border claims of Western European banks in the whole CEE region are 5% to 1% below their 28-levels, while overall international exposures or exposures to Western Europe (by Western European banks) were slashed by around 35% to 4% during the same period of time. Cross-border exposures of Western European banks to the countries of the so-called euro area periphery were even cut down by some 7% from 28 to 214, reflecting a trend of national re-orientation and substantial (cross-border) deleveraging in overall European banking. The Banking Union implementation (including the AQR exercise, stress testing etc.) added to the deleveraging process at Western European banks that are in a defensive mode regarding their international operations anyway (e.g. compared to international peers). That said, there is also a general trend of global cross-border banking deleveraging, also driven by regulatory tightening for cross-border exposures as well as a refocusing of business strategies (see also the Global Financial Stability Report 215, International Banking After the Crisis: Increasingly Local and Safer?, Chapter 2, pp ). A critical reflection of the success of the Vienna Initiative in stabilizing cross-border funding as well as crisis experience within Western European banking sectors shows that regulation should clearly focus on the risks stemming from excessive cross-border funding and lending that is not backed by deep ownership links (or in other words, an equity-based cross-border integration). At the same time, cross-border funding to CEE (and especially in the CE and SEE region) had been fairly stable in the recent challenging years. The overall commitment of leading Western European banks to their large and locally embedded franchises in CEE can be seen by the development of CEE exposures compared to overall international exposures in Western European banking sectors of systemic importance for the CEE region, i.e. those in Austria, Italy and France. In these three banking sectors, cross-border exposure to CEE developed much more favorably than overall international exposures or the CEE exposures of other Western European banking sectors. The relatively stable cross-border exposures to CEE in general and the CE region in particular are also a reflection of the fact that, up to now, all larger divestments of Western European banks in the region involved another Western European bank on the buyer side. Nevertheless, leading Western CEE banks also had to adjust their exposures in the region. Recent regulatory tightening was a blow to less profitable and funding-consuming (but possibly still moderately profitable) business lines and markets. It also became more challenging for banks to pursue long-term strategies, which may offer less short-term profit, while profits and retained earnings are currently the best means to shore up capital positions and to meet regulatory and/or market demands in terms of capitalization. Moreover, the overall modest cuts in cross-border exposures towards the whole CEE region are partially hiding increasingly selective country strategies. In some countries (such as Poland, Slovakia or the Czech Republic), there was definitely no pull-back of Western European banks. However, in the more challenging SEE markets, as well as in Hungary, Slovenia, Ukraine and since 214 also in Russia, they pursued more conservative business strategies. Due to this de-risking, Western European banks were by and large increasing their gearing towards markets with lower macro-financial risks, lower NPL ratios (i.e. less legacy problems) and better profitability. Moreover, the modest reduction in cross-border exposures also reflects still limited new lending dynamics, a turn to more local refinancing and finally also selling (to non-bank investors) or write-offs of certain NPL exposures (like in SEE or Ukraine). Western European banks, who are still key providers of liquidity and financing to Russia, turned more conservative in terms of cross-border exposures to the country in 214, a clear decoupling of overall trends in emerging markets banking. Many drivers for the most recent reduction of cross-border exposures to Russia (higher macro-financial risks, weak developments in the domestic economy and in external trade in comparison to other emerging markets, more conservative business strategies of Western corporate clients in Russia, and Western sanctions) are likely to stay well into 216. This is why overall cross-border exposures to CEE are likely to see some downward pressure in 215, mainly driven by decreasing exposures to Russia and still limited need for large cross-border financing in most CE/SEE markets as indicated by low L/D ratios. From a strategic perspective, the Deleveraging debate in CEE also reflects a certain dilemma for leading Western European CEE-lenders. On the one hand, they delivered on their regional commitment and were sometimes even criticized by regulators or IFIs for trimming their exposures in certain markets in a modest way (e.g. in the regular CESEE Deleveraging and Credit Monitor ). On the other hand, their European competitors with a focus on Western and global business improved their capitalization ratios via substantial deleveraging in international business. Capital ratios were raised substantially in the EU and the euro area, and this was partially achieved via substantial cross-border deleveraging. Given the modest deleveraging compared to their Western European peers, it comes as no surprise that most leading Western European CEE banks (still) have lower capitalization ratios than their peers (page 2) with a focus on non-cee markets (although there are other drivers for this development as well). Financial analyst: Gunter Deuber, RBI Vienna Cross-border claims* Dec 9 Feb 11 Apr 12 Jun 13 Aug 14 AT, IT, FR banks CEE European banks CEE AT, IT, FR banks Dev. Markets European banks Dev. Markets * Dec 29 = 1, latest data point Q4 214 Source: BIS, RBI/Raiffeisen RESEARCH Please note the risk notifications and explanations at the end of this document 11

12 Banking trends in CEE Loan growth, growth by segments (retail, corporate) CEE: Loan-to-GDP ratio 6% 5% 4% 3% 2% 1% Loan-to-GDP ratio 75% 6% 45% 3% 15% % CE SEE EE Source: national central banks, RBI/Raiffeisen RESEARCH Hungary Romania CE-3 (PL, CZ, SK) SEE (excl. RO) Source: national central banks, RBI/Raiffeisen RESEARCH CE/SEE vs. EA loan growth (% yoy) Major trends in the regional CEE loan-to-gdp ratios are a reflection of the asset growth picture sketched previously (relative stability in CE, downward trend in SEE, distorted increase in EE with a massive impact on the overall CEE trend). In combination with currency effects, the total CEE loan stock posted a drop in 214 (down from EUR 1.37 bn to EUR 1.2 bn). In relation to bank loans inside the euro area, the overall CEE loan stock dropped from 11.7% in 213 to 1.4% in 214 (driven by currency devaluation effects as well as a slightly increasing loan stock inside the euro area). Once again the drop was mainly driven by the EE region, as the CE/SEE total loan stock remained more or less flat in 214, at around EUR 55 bn or 4.7% of total loans inside the euro area. Hence, in terms of loan growth there was at least no significant underperformance of CE/SEE markets compared to the euro area in 214 (where total loan growth stood at.2% after two years of decline). Nevertheless, in 214 overall loan growth remained modest in CE and SEE as indicated by a CE/SEE loan stock that remained virtually flat in nominal terms. But stark country differentiation prevails. CE banking markets once again strongly outperformed SEE markets. Annual CE loan growth in LCY-terms came in at 5.1% yoy in 214 and at 1.5% in EUR-terms, while the respective annual growth rates in SEE stood at -2% in LCY-terms and -2.9% in EUR-terms yoy. Real loan growth in CE/SEE in LCY-terms, largely driven by the larger CE banking markets, reached some 3% yoy in 214, which has been the strongest level since 211 and quite decent given the subdued inflation developments. Therefore, the 214 loan-to-gdp ratios increased by several percentage points in the CE markets without adjustments needs (like in Hungary or Slovenia). Due to contracting loan stocks, the overall SEE loan-to-gdp ratio (mainly driven by Romania, Bulgaria and Croatia, where loan stocks were dropping in both LCY- and EURterms) dropped modestly from 5% to 48% in 214. Now the ratio stands some 5 pp below the peak levels of 53% (reached from 21 to 212) reflecting broad based regional deleveraging needs. As already mentioned, the strongest regional adjustment was observed in Romania, mainly driven by regulatory tightening related to NPL exposures, which caused write-offs and NPL sales. There could be similar adjustment needs in other SEE markets with similar high loan and NPL stocks, that have not been addressed yet. CEE vs. EA: Long-term loan-to-gdp ratio trends 3 5 6% 15% % 4% 14% 13% % 12% CE/SEE (total loans) Euro area (total loans, r.h.s.) 2% 11% Source: national central banks, ECB, RBI/Raiffeisen RESEARCH 1% % CEE total loans (% of GDP) Euro area total loans (% of GDP, r.h.s.)* * Excluding MFI-business Source: national central banks, ECB, RBI/Raiffeisen RESEARCH 12 Please note the risk notifications and explanations at the end of this document

13 Banking trends in CEE Hungary, Slovenia and Romania saw drops in their loan-to-gdp ratios by some 1 pp to 2 pp in recent years. We consider Hungary and Romania ready for a new lending cycle (especially in LCY lending), which cannot be said about some other SEE banking markets. In euro area countries with substantial deleveraging needs, like Spain or Portugal, recent drops in loan-to-gdp ratios were even more extreme (in absolute and relative terms) than in the CE/SEE region. In light of deleveraging experience in selected CEE markets and inside the euro area, we see a fair chance that at least 3% to 5% of a brisk pre-crisis expansion of the loan-to-gdp ratio has to be corrected within a deleveraging phase (either via less credit-driven economic growth and/or loan write-offs). From a longer-term perspective, the outperformance in the by and large more healthy CE banking sectors compared to SEE markets is even more striking. The cumulative loan growth from 211 to 214 stands at 18% in LCY-terms or 8% in EUR-terms. On contrary, in SEE the cumulative loan growth was just some 6% in LCY-terms or 1% in EUR-terms over the same period of time. Putting the cumulative LCY loan growth rates in relation to cumulative nominal GDP growth, the recent SEE deleveraging becomes even more obvious. From 211 to 214, nominal GDP growth in SEE stood at 2% (i.e. well below loan growth), whereas in CE loan growth was at least slightly outpacing cumulative nominal GDP growth at 16%. Since the overall CE aggregate was driven down by a negative performance in Hungary and Slovenia, the real loan growth in the other CE markets was even higher. The overall loan growth in most CE/SEE banking sectors currently remains geared towards more short-term transactions in corporate and retail lending as well as mortgage lending. In many CE/SEE markets with the possible exception of Poland for overall corporate lending and Hungary for SME lending corporate lending growth remains below expectations and mostly focused on working capital financing. The focus of many CEE banks on retail lending seems to be explained by still higher margins and better (risk-adjusted) return prospects. However, the recent substantially increased consumer protection on EU and CE/SEE banking markets should also support cautious business strategies in retail lending, in order to avoid unpleasant restructuring issues later on. Deleveraging Western Europe/EA* Spain Portugal Ireland UK Start credit cycle Peak 214 * Loan-to-GDP ratio (%), period from Source: national central banks, ECB, RBI/Raiffeisen RESEARCH Deleveraging CE/SEE* Hungary Romania Slovenia Start credit cycle Peak 214 * Loan-to-GDP ratio (%), period from Source: national central banks, RBI/Raiffeisen RESEARCH Interestingly, SEE banking markets are not clearly underperforming their CE peers in mortgage lending. In some countries, there is also government support for mortgage lending. Moreover, customers are currently attracted by the fairly low nominal interest rates and are refinancing existing mortgage loans. In some CE/SEE markets strong retail/mortgage lending has led to an increasing regulatory alertness. In some cases, like Slovakia, recommendations aiming at more prudent retail/mortgage lending standards were issued. From a through-the-cycle perspective and given the positive experience on the Polish banking sector, such recommendations should be welcomed. This holds especially true as the mortgage loan penetration in CE and Croatia is not very low anymore and steadily increasing. Here mortgage loan-to- GDP ratios are currently hovering at around 2% of the GDP. At first sight such levels seem low compared to the average euro area mortgage loan-to- Mortgage loans (% of GDP) 5% 4% 3% 2% 1% % Poland Hungary Czech Rep. Slovakia Slovenia CEE * Larger EA countries with lowest mortgage loan-to-gdp ratios in 22 (AT, FR, BE, IT) ** Larger EA countries with highest mortgage loan-to-gdp ratios in 214 (NL, ES, FR, DE) Source: ECB, national sources, RBI/Raiffeisen RESEARCH Romania Bulgaria Croatia Russia Average Low* Euro area High** Please note the risk notifications and explanations at the end of this document 13

14 Banking trends in CEE CE: Loan growth LCY- vs. EUR-terms 35% 25% 15% 5% -5% CE loan growth (% yoy, LCY) CE loan growth (% yoy, EUR-based) Source: national central banks, RBI/Raiffeisen RESEARCH SEE: Loan growth LCY- vs. EUR-terms 5% 4% 3% 2% 1% % -1% SEE loan growth (% yoy, LCY) SEE loan growth (% yoy, EUR-based) GDP ratio at some 38% (some countries like Spain, France or the Netherlands even have a mortgage loan-to-gdp ratio of up to 4% to 6%). In this context, it is also worth mentioning that a decade ago and before the most recent sustained financial cycle (with some excesses inside the euro area) mortgage loan-to-gdp ratios in some euro area countries, like Austria, Belgium and France, had been as low as 16% to 2% (which are current mortgage loan penetration ratios in several CE/SEE economies). In Russia, overall loan growth, like the asset growth, looks inflated for 214. The Russian banking sector actually posted a higher loan growth rate in 214 yoy, although the overall economy was moving into a different direction. Even when corrected for FX effects, the overall 214 loan growth came in at fairly high levels of 12% to 15% yoy. This development is the result of a complex mix of various factors, while the overall market trends in Russia are definitely opposite to the picture in most other CEE banking markets. Corporate loans showed a striking increase, accelerating in the second half of 214. Robust corporate lending growth was mainly driven by the idea to draw on all existing and still available credit lines to secure an adequate cushion for (external) debt repayments (as indicated by the fact that corporate deposits also increased in times of strong loan growth). State-support also played an important role here. Strong corporate loan growth, driving the overall market growth, was even over-compensating for a continuous decline in retail loan growth with an above average decline in activity in longer-term transactions, including mortgage loans. As a result, the share of corporate loans in total loans increased to around 77% at Russian banks levels seen from 25 to 21, i.e. before the strong retail lending boom. A somewhat similar trend was visible in Ukraine, where the corporate loan stock in total loans also increased in 214, to a level of 8%. Therefore, the looming restructuring in corporate exposures and related-party lending at Ukrainian lenders, as requested by the IMF, will affect large parts of the local banking sector (page 54). Financial analyst: Gunter Deuber, RBI Vienna Source: national central banks, RBI/Raiffeisen RESEARCH Funding, deposit growth and L/D ratios EE: Loan growth LCY- vs. EUR-terms 75% 5% 25% % -25% EE loan growth (% yoy, LCY) EE loan growth (% yoy, EUR-based) Source: national central banks, RBI/Raiffeisen RESEARCH The past years trend in core funding dynamics in CEE, and its relation to the lending base, saw a continuation in 214 as well. The aggregated loan-to-deposit (L/D) ratio across the CEE banking markets remained stable at some 97% (i.e. notably below its peak at 114% in 28). Two general tendencies contributed to that in 214. First, the CEE L/D ratio, well below its peak levels, is a clear indication that the times of very strong loan growth across CEE markets are over. Second, the increasing reliance on local funding is also a reflection of the global trend to decrease cross-border banking flows and penetration that is driven by market and regulatory forces (see also the focus on page 11 about cross-border financing in CEE banking markets.) Thus, the predominantly conservative lending behavior of CE/SEE banks was going in parallel with still sanguine deposit dynamics within the banks. 214 was another good year for deposit funding growth in the entire CEE area, notwithstanding some countries headwinds, that left the respective banking systems in a tougher funding situation (e.g. Bulgaria, Russia and Ukraine). That said, 14 Please note the risk notifications and explanations at the end of this document

15 Banking trends in CEE it is possible that the CEE region s low L/D ratio may witness something like a turning point in the lending cycle. Given the rebalancing of the L/D ratio in most of the countries, and especially in those countries with the strongest macro-performance, we see sufficient room to finance a new, but more cautious, lending cycle going forward. In particular in those CE markets without secular deleveraging needs (i.e. the Czech Republic, Poland and Slovakia) the trend of loan and deposit growth continued in 214 at more or less similar levels, with a slightly stronger deposit growth in comparison to loan growth. Poland, for example, enjoyed deposit growth rates close to 1% yoy, the Czech Republic at 3% yoy and Slovakia at 4% yoy, all in LCY-terms. Banking markets with secular deleveraging needs (i.e. SEE as well as Hungary and Slovenia) continued to show a significantly stronger growth in deposits than in loans. In SEE, the leaders in deposit growth were Bosnia and Herzegovina, Romania and Serbia, each posting a 8% yoy customer fund s growth. Like in previous years, the weakest core funding dynamics were in Hungary with 2% yoy (LCY-denominated) and Croatia with zero growth. Bulgaria, which managed to recover after the mid-year banking sector turmoil, posted a modest 2% yoy deposit growth (LCY-terms). CEE: FCY loans (% of total) CE SEE EE Source: national sources, Raiffeisen RESEARCH Across the CEE countries, the dynamics in EUR-terms were more diverse, as determined by the multidirectional trends in the local exchange rates, and in particular in Russia and Ukraine. As a result, the total deposit stock in the overall CEE area was significantly down by 1% (yoy, in EUR-terms) in 214. This includes a decline of 4% in Ukraine and of 18% in Russia as well as a 4% decline in Hungary, which resulted from a HUF depreciation against the EUR of about 4%. In SEE, the regional L/D ratio has reached the lowest level since 26, with around 9% in 214. A similar pattern also revealed in Hungary and Slovenia, where the L/D ratios reached their lowest levels over the past decade. In our view, this has come as a clear reflection of a need for deleveraging and restructuring on the asset side (i.e. low loan growth, managing high stock of NPLs), while deposit growth remained at solid levels. In the EE region, the deposit growth and L/D ratio posted decreases in 214. The L/D ratios in Russia have been gradually rising since the 28/9 downward adjustment, while we view the recent L/D ratio increase in Ukraine as a crisis-induced phenomenon (the country s L/D ratio was on a downtrend before 214). CEE: Loan-to-deposit ratio 125% 115% 15% 95% 85% 75% CE SEE EE Source: national central banks, RBI/Raiffeisen RESEARCH CEE: Loan-to-deposit ratios at the country level (%) 16% 14% CEE vs. EA: Loan-to-deposit ratio 12% 12% 11% 1% 8% 1% 6% 4% 9% 2% % 8% Poland Hungary Czech Rep. Slovakia Slovenia* Romania Bulgaria Croatia Serbia Bosnia a.h. Albania Russia Ukraine* Belarus* CEE Euro area Source: national central banks, RBI/Raiffeisen RESEARCH CE SEE EE * Scale capped at 16%; Slovenia, Ukraine and Belarus in 28 with values above 16%; Sl: 166%, UA: 25%, BY: 171% Source: national central banks, RBI/Raiffeisen RESEARCH Please note the risk notifications and explanations at the end of this document 15

16 Banking trends in CEE Profitability (Return on Assets, Return on Equity) CEE: Return on Equity (%) CE SEE EE CE (excl. Hungary) Source: national central banks, RBI/Raiffeisen RESEARCH Profitability in CEE banking was a mixed bag in 214. The overall CEE banking RoE has reached its lowest level at some 6.9% since the year 2. This disappointing performance can be attributed to several factors. First, in 214, three markets in the region, namely Hungary, Romania and Ukraine, turned negative, which is a significant worsening compared to 213, when only Slovenia made a loss and marks one of the worst years in CEE banking. Only in 21/11 the situation in the region was worse, with four loss-making banking markets. Although the losses were partially related to one-off effects, the RoE readings in the three affected markets were deep in the red (HU: -11%; RO: -12.5%; UA: -3%). The losses in the Hungarian and Romanian banking sector had a substantial impact on leading Western CEE banks given the still high foreign ownership in both banking sectors. The average foreign ownership ratio on loss-making CEE banking markets reached 61% in 214 (compared to 57% back in 211). CEE: Return on Assets (%) CEE: Loss-making banking markets* CE SEE EE Source: national central banks, RBI/Raiffeisen RESEARCH Number of countries with negative RoE * out of 14 CEE banking sectors covered in this report (loss-making 214: HU, RO, UA) Source: national central banks, RBI/Raiffeisen RESEARCH Second, in 214, the overall profitability pressure was notable also in profitable CE markets like Poland, the Czech Republic and Slovakia and resulted in a further round of profit compression from already low levels by historical regional standards. The regional CE RoE dropped from 1.3% to 9.2%; excluding Hungary, the regional RoE decreased from12% to 11.7%. Due to the relative maturing of the CE markets, the risk premium in the region went down, supporting the respective downwards pressure on profitability. Nevertheless, we want to emphasize that the CE countries currently have the greatest potential for banking business in CEE. In SEE, the negative performance of the Romanian market (RoE: -11.6%) was overwhelming. In the other SEE markets, the average RoE has remained at meagre 3% and thus at a disappointing level ever since 29. Finally, the lower RoE margins in the CEE area reflect the new European regulatory requirements that are pushing banks towards larger capital buffers. The lower ratio of return to equity in the CEE region, per se, was determined by the increase in denominator value (E: Equity), while Western European banks were acting towards being in accord with the new European capital requirements, and also domestic regulators were increasingly solidifying banking sectors capitalization in their countries. CEE vs. EA: Return on Equity (%) CEE Euro area Source: national central banks, ECB, RBI/Raiffeisen RESEARCH 16 Please note the risk notifications and explanations at the end of this document

17 Banking trends in CEE Focus: Non-performing loans and NPL ratios Regarding NPL ratios, 214 was finally a turnaround year in the CE and SEE banking sectors and brought dropping ratios after years of increases. In CE, the positive regional NPL ratio trend got support from solid and/or improving asset quality and new lending activity in markets like Poland, the Czech Republic and Slovakia, while asset quality was finally also improving in hard-hit Hungary (NPL ratio down from 14% to 13.3%) and Slovenia (down from 22% to 16%). The overall NPL ratio in the CE region improved from 9.1% to 8.5%, the regional NPL ratio excluding Hungary dropped from 7.1% to 6.8% in 214. Hence, on a regional level (whole CE aggregate) the NPL ratio dropped by.6 pp in 214 following five consecutive years of a cumulative increase by 5.2 pp. It is likely that an even larger drop in the regional CE NPL ratio would have been possible, however, the ECB s AQR led to more cautious assessments of the asset quality in the affected banking sectors (directly or indirectly part of the SSM). CEE: NPL ratios* CE SEE EE * % of total loans Source: national sources, RBI/Raiffeisen RESEARCH The regional SEE NPL ratio dropped by some 5 pp from 19.5% in 213 to 14.8% in 214. This turnaround follows an overall increase of 16 pp between 28 and 213. This NPL drop mainly stems from a substantial balance sheet clean-up in Romania (with increased provisioning, write-offs and asset sales) as well as stabilizing or slightly improving NPL ratios in some other SEE markets (like Albania, Bulgaria and Bosnia and Herzegovina), partially supported by a mild lending recovery. In Croatia and Serbia, the NPL ratios continued to inch higher throughout 214 and in both markets we expect the asset quality either deteriorating further or stabilizing only very gradually in 215. In the SEE region, 3% of the NPL ratio increases of the years 28 to 213 were reversed in 214 three times as much as in the CE region. The boldness of the NPL ratio turnaround in SEE was reflected in a negative profitability performance of the overall SEE banking sector, largely driven by Romania, where the banking sector was once again loss-making in 214. In 214 and also in 215, Romania saw a larger number of NPL sales transactions, that may finally pave the way for more transactions to follow in Romania and possibly other markets (e.g. also part of strategic restructuring or possible divestment and M&A transactions). As a first candidate for potential NPL sales transactions we see Hungary. Like Romania, Hungary is a large banking market (by regional standards) and hence decent sized NPL transactions are possible. In addition, the EU jurisdiction in Hungary and an economic turnaround, driven by domestic demand, seem to be supportive factors (like in Romania). In the other SEE markets with high NPL levels, namely Albania, Bulgaria, Croatia and Serbia, we doubt to see NPL sales transactions, as at least one or several previously mentioned criteria are not fulfilled. Here we expect banks to continue with internal work-out procedures for the time being. The combined CE/SEE NPL ratio dropped from 12% to around 1% in 214. In contrast, NPL ratios inched up in all EE countries and we expect this trend to continue in 215. The NPL ratio in Russia increased from some 4.2% in January 214 to 5% in December 214. However, 214 was still characterized by modest asset quality deterioration, also supported by strong loan (which led to a downward bias in the NPL ratio). For 215, we expect a stronger deterioration of asset quality due to the looming recession of the Russian economy. The first months of 215 already brought a strong rise of the NPL ratio from 5% to 6% (April), with 7.1% of NPLs in retail and 5.6% in corporate lending. Currently, we expect the Russian NPL ratio to reach 8% to 1% of total loans (depending on loan growth dynamics) in 215, while the overall restructured loans are expected at 2% to 3%. In Ukraine, we see IFRS-based NPL ratios once again at around 4%, while the recent adverse conditions may add 1 pp to 15 pp to this already high NPL stock. The looming structural banking sector clean-up (as requested by the IMF support package) may also add to NPL formation in 215. This may finally pave the way for a more sustained NPL resolution in 216 and beyond. In total, the diverging NPL ratio trends in the three CEE subregions were still somewhat offsetting each other in 214, resulting in a fairly stable overall CEE NPL ratio of 8.5%. However, in 215 the developments in EE could overshadow positive NPL developments in other CEE markets, a scenario that may lead to an increase of the total CEE NPL ratio to above 9% until year-end 215. Financial analyst: Gunter Deuber, RBI Vienna CEE: Markets with NPLs <1%* BY SK RU** CZ PL * year-end 214; ** RU: Latest data as of April 215 Source: national sources, RBI/Raiffeisen RESEARCH CEE: Markets with NPLs > 1%* HU RO SI BH BG HR RS AL UA* * UA: based on IFRS estimates, official ratio much lower; year-end 214 Source: national sources, RBI/Raiffeisen RESEARCH Overall CEE NPLs CEE NPLs (total EUR bn) CEE NPLs (% of total loans, r.h.s.) Source: national sources, RBI/Raiffeisen RESEARCH Please note the risk notifications and explanations at the end of this document 17

18 Banking trends in CEE CE: Return on Equity (RoE, %)* 2% 15% 1% 5% % -5% -1% -15% HU SI** SK PL CZ * countries sorted by 214 RoE ** scale capped at -15%; Slovenia RoE 213: -31.6% Source: national sources, RBI/Raiffeisen RESEARCH As a result, given the profitability pressure in key CE/SEE markets, the regional RoE dropped to below 6%, which is hardly above the current RoE inside the euro area and in Western European banking. In the CE/SEE region, the 214 RoE marks a new 15-year low (previous lows were at around 9% in 29/1), while the RoE of about 5% in Western European banking represents a recovery. Hence, the overall appeal of CE/SEE banking markets vs. euro area peers suffered a lot in 214, with the exception of Poland, Slovakia and the Czech Republic. Also and important for the CEE banking in general, this time around EE markets could not offer any meaningful compensation for the profitability pressure in CE/ SEE banking. In fact, in 214 there was a significant positive profitability gap between the CE RoE and the RoE in the EE banking sectors. In the second half of 214, the Russian banking sector RoE dropped to 7.9%, which is still well above the 4.9% crisis-driven slide recorded in 29. But given the further pressure on profitability, the expectations for 215 are still on the downside (Q1 215 RoE at 4.8%). The overall RoE in the EE banking markets stood at around 7% in 214, i.e. hardly above the average RoE on the CE/SEE banking markets, which bear a notably lower risk profile at the same time. SEE: Return on Equity (RoE, %)* 15% 1% 5% % -5% -1% -15% RO RS HR BH BG AL * countries sorted by 214 RoE Source: national sources, RBI/Raiffeisen RESEARCH EE: Return on Equity (RoE, %)* 2% 15% 1% 5% % -5% -1% UA** RU BY * countries sorted by 214 RoE; ** scale capped at -1%; Ukraine RoE 214: -3% Source: national sources, RBI/Raiffeisen RESEARCH Depending on the strength of the turnaround in larger CE/ SEE markets, in 215 the profitability of the CEE banking sector could fall below the one in Western European banking. This would be a first ever since the year 2, when the CEE region was still characterized by the aftermaths of the Russian crisis of 1998/99. Similar to the situation in Western Europe and given the current profitability in the region, Western banks could barely recoup their equity costs in CEE. The fact that the current profitability in the CEE region is only slightly above the levels in Western European banking will add to pressure on market players in the region and may result in further consolidation and strategic re-orientation. Respectively, given the near-term profitability expectations (put in risk-adjusted return perspective or in relation to funding costs), it will be difficult to sustain large and capitalconsuming franchises in some SEE markets, Russia or Ukraine. In 214, the aggregated RoA in CEE developed similarly to the RoE in the region. The RoA stood at fairly disappointing.8%, which is the same low level like back in 29. In the SEE and EE banking sectors, the 214 RoA readings were just at some 4% of their pre-crisis values, with the 214 RoE at just around 5% of long-term pre-crisis values. The positive exception is once again the CE region, where the core profitability in terms of RoA remains at 64% of its longterm pre-crisis average and hence above the RoE (56% of its long-term pre-crisis average), which reflects the higher capitalization levels in the region. Excluding Hungary, the CE RoA is even better at 87% of its pre-crisis average vs. RoE of 75%. All in all, the profitability outlook for CEE banking remains challenging. Profitability pressure is likely to stay in the few lucrative CE markets. In Slovakia there is some upside to profitability due to the reduction of the fairly high banking tax. In other larger markets, like Hungary or Romania, it is difficult to predict to what extent a turnaround in profitability can be achieved in 215. In Romania, the plan to join the SSM is likely to result in further tough stress testing and possible adverse effects on the local banking market. Moreover, potential settlement to CHF exposures could lead to negative effects in Poland, Croatia and partially also in Romania. Furthermore, we expect profitability pressure to stay on the Russian market. Here the main factors will be the ability of the CBR to cut rates substantially without damaging the RUB stability, the pace of asset quality deterioration as well as the ability of Russian banks to cut costs and restructure their franchises. The previous credit growth cycle supported fairly expansionary and aggressive strategies, while cost inflation was a long-standing issue. Financial analysts: Gunter Deuber, Elena Romanova, RBI Vienna 18 Please note the risk notifications and explanations at the end of this document

19 Banking trends in CEE CEE banking growth and overall market outlook According to our current assessment, the prospects for CEE banking in 215 and 216 are likely to be shaped by a complex mix of supportive factors, but also headwinds (related to legacy issues and new challenges). On a positive note, CEE banks are likely to profit from the adjustments and positive trends seen in major CE/SEE banking markets in recent years and in 214 in particular (e.g. deleveraging, improved L/D ratios, petering out of asset quality deterioration, increased tackling of NPL stocks). The increasing economic momentum in Western Europe and CE/SEE markets adds to the uplift in CE/SEE banking. This holds especially true as in CE/SEE markets economic growth is increasingly generated by domestic drivers. Such a situation should translate into growing demand for new lending and investment financing as well as longerterm transactions. Therefore, corporate lending and also SME lending may develop in a more favorable way going forward. Up to now, positive dynamics in these two segments were limited to Poland and Hungary. Over the recent one to three years, loan growth in CE/SEE markets was largely driven by short-term transactions (like consumer financing or working capital financing), refinancing CEE: Long-term banking growth outlook: Larger markets Average annual loan growth rate f (% yoy in LCY-terms) 14% 13% 12% 11% 1% 9% 8% 7% 6% Romania Czech Republic Russia Poland 5% Banking growth outlook (EUR- vs. LCY-terms) Current loan stock Loan stock growth* Avg. growth f EUR bn EUR bn % yoy, EUR Avg. growth f % yoy, LCY PL % 8.8% HU % 6.8% CZ % 6.6% SK** % 8.1% SI** % 4.% RO % 12.4% BG** % 3.8% HR %.1% RS % 7.6% BH** % 4.4% AL % 8.8% RU % 9.3% UA % 19.3% BY % 15.% Regions CE % 8.2% SEE % 8.1% EE % 1.3% CEE 1, % 9.5% * From f in nominal EUR-terms ** In SK, SI, BG and BH loan growth rates in LCY and EUR are matching due to EA membership or Currency Board arrangements Source: national sources, RBI/Raiffeisen RESEARCH Change in total loan volume year-end f (EUR bn) Source: national sources, RBI/Raiffeisen RESEARCH CEE: Long-term banking growth outlook: Smaller markets* Average annual loan growth rate f (% yoy in LCY-terms) 14% 12% 1% 8% 6% 4% 2% % Albania Croatia Bosnia and Herzegovina Serbia Bulgaria Slovenia Hungary Slovakia Change in total loan volume year-end f (EUR bn) * Ukraine and Belarus not shown due to expected decline in loan stock in EUR-terms Source: national central banks, Raiffeisen RESEARCH Please note the risk notifications and explanations at the end of this document 19

20 Banking trends in CEE Banking growth trough-the-cycle* Average loan growth f PL 15.2% 6.8% 8.8% HU 17.7% -4.7% 6.8% CZ 6.7% 4.8% 6.6% SK 1.9% 6.5% 8.1% SI 15.8% -8.8% 4.% RO 4.3%.6% 12.4% BG 34.%.9% 3.8% HR 16.2%.6%.1% RS 49.8% 4.4% 7.6% BH 16.7% 3.8% 4.4% AL 36.3% 8.8% 8.8% RU 38.% 22.1% 9.3% UA 48.1% 7.9% 19.3% BY 67.2% 36.7% 15.% Regions CE 13.% 4.5% 8.2% SEE 27.9% 1.5% 8.1% EE 39.7% 21.5% 1.3% CEE 31.2% 14.8% 9.5% * Loan growth rates in LCY-terms Source: national sources, RBI/Raiffeisen Research CET-1 ratios (%)*** Avg. large Avg. 3 leading Europ. banks** Western CEE banks* Year-end 214 Chg. CET-1 ratio 214 vs. 213 (bp, r.h.s.) * RBI, Erste, UniCredit ** Swedbank, SEB, Nordea, Danske, Intesa, Deutsche, HSBC, Standard Chartered, ING, SocGen, BNP, Commerzbank, Santander *** CET-1, fully loaded Basel III pro forma CET-1 ratios Source: company data, Bankscope, RBI/Raiffeisen RESEARCH and/or debt restructuring transactions. Given the fact that deleveraging and restructuring seem to be largely completed on larger CE/SEE markets, like Hungary and Romania, as well as the absence of restructuring and deleveraging needs in Poland, the Czech Republic and Slovakia, CE/SEE banking sector assets may develop in a fairly positive way over the next one to two years. As a result, deleveraging and restructuring needs in markets like Croatia, Serbia or Bulgaria are likely to be overcompensated by positive developments elsewhere. In contrast to the encouraging banking outlook in CE/SEE on the operational level, banking dynamics in the EE region are likely to be less impressive in 215. We see tough times ahead on the Russian market although RUB stabilization as well as the ability to bring funding costs back to more normal levels may help to avoid larger downsides in terms of restructuring needs and write-offs. The Ukrainian banking market is likely to see another year of hefty losses and recapitalization needs, and also the Belarusian economy is facing tough economic challenges in the year ahead. Moreover, there are also broader and longer-term challenges in CEE banking (e.g. regulatory pressure, capital and profitability pressure) that may constrain the near-term upside offered by increasing economic and banking sector growth momentum in CE/SEE. For instance, the effects of the ultra-low rates environment are likely to gradually feed into the banks portfolios in 215 and 216 (as indicated by strong profitability pressure on CE markets that are characterized by solid asset quality). Moreover, market strategies of major Western CEE banks are increasingly focusing on just a few markets, which will add to profitability pressure. On the regulatory side, the handling of CHF loan stocks in several CEE countries, like Poland or Croatia, adds to uncertainty, as individual players could face significant costs of restructuring. Overall regulatory and market trends in European banking are also likely to spill over to CEE banking. Some CEE banking sectors in non-euro area countries may finally join the SSM on a voluntary basis which may imply a need for strict stress testing and balance sheet clean-up. Moreover, joining the SSM may also add to profitability pressure due to the need to build up crisis funds as requested within the SRM framework. Furthermore, overall European regulatory pressure is likely to continue impacting on CEE banking sectors, e.g. via continuous ECB stress-testing or the continuous focus on capital and profitability planning (following years of subdued profitability in CEE banking). Such broader trends in European banking could particularly challenge larger Western European CEE banks operating in the region. They are still characterized by fairly low capitalization levels compared to major European peers and measured by current market standards, while doing business on CEE markets is likely to require more capital for future growth than operations in Western European markets. Besides, internal capital generation capability is likely to be challenged by the currently very subdued profitability outlook in CEE banking. For some leading Western CEE banks the results of the 214 stress testing and AQR were a mixed bag. Therefore, ongoing restructuring at leading Western CEE banks is mainly targeting capital positions, while adjustments were largely achieved via asset sales, balance sheet optimization and only to a lesser extent via outright capital increases and financial market transactions. We expect cautious and very selective business strategies of larger Western European banks, characterized by capital discipline as well as a stark differentiation between country and business segment strategies, to prevail in 215. Consequently, overall business strategies in CEE banking are likely to be dominated by balance sheet optimization, cost-cutting and very selective growth and investments strategies focusing on product optimization, modernization and operational efficiency. Hence, it is unlikely to see new market entries or large-scale expansions of ex- 2 Please note the risk notifications and explanations at the end of this document