February 23, 2009—Just six months ago, banks in central and Eastern Europe were flush with cash. Some thought they might even escape the credit crisis hitting the United States.
But the region did not escape. Low interest rates and easy credit have given way to a dearth of liquidity and capital problems in the banks amid slowing global growth and trade.
World Bank President Robert B. Zoellick has called on Western European governments to support cash-starved Central and Eastern Europe, now seen as the new epicenter of the financial crisis. He says the region needs $120 billion to recapitalize banks.
For its part, the World Bank Group, including IBRD, IFC and MIGA, is working with the European Bank for Reconstruction and Development (EBRD) and the European Investment Bank to see whether, within the IMF’s macroeconomic reform plan, “we can help restructure and recapitalize,” Zoellick told the Financial Times.
“But we are going to need help from the European governments, because whether accidentally or not, part of the problem will be whether Western European banks withdraw liquidity from Central and Eastern Europe,”
Recapitalization Key Part of Proposed Vulnerability Fund
Bank recapitalization is a key element in the World Bank Group’s response to the global financial crisis. Other tools include funds to boost trade, safety nets, and infrastructure development, and providing political risk insurance to banks (MIGA).
The Bank also has the capacity to triple lending (IBRD) this year to $35 billion and has sped up delivery of its $42 billion fund (IDA) for the poorest countries.
Zoellick is urging developed nations to contribute 0.7 percent of their stimulus packages to a special Vulnerability Fund for developing countries that can’t afford their own stimulus packages.
“This is not a crisis of one region, it’s a global crisis. It needs a global solution,” Zoellick said. “That partly means you need to strengthen the developing countries to be part of the solution.”
New Fund Seeks Systemic Impact
The Bank Group’s IFC created the new $3 billion IFC Recapitalization Fund last December to strengthen banks that may face liquidity problems in Asia, the Middle East and North Africa, Sub-Saharan Africa, Latin America and the Caribbean, and Central and Eastern Europe.
Since then no region has proven to be immune to the far-reaching global crisis.
“Liquidity has completely dried up in certain countries in Africa. Non-performing loans have gone up,” says Jyrki Koskelo, an IFC vice president overseeing the fund.
“Countries in Latin America are equally badly affected. It’s not as dramatic as in Eastern Europe, but it’s quite bad.”
The fund, expected to announce its first investments at the end of March or early April, currently has $1 billion from IFC and another $2 billion from Japan through the Japan Bank for International Cooperation. The Bank Board has approved a cap of $5 billion, but sub-funds to boost funding for specific regions may also be possible.
Fund Would Have Leveraged Impact of $75 Billion
Koskelo says the goal is to strengthen important banks in smaller, poorer countries where relatively small amounts of money, along with IFC advisory services, could have an impact on the banking system and economy.
Such banks could be domestic banks or subsidiaries of foreign banks such as those that dominate the sector in Central and Eastern Europe.
“We want to have a far-reaching impact on banking systems and help where we can actually make a difference,” says Koskelo.
While the overall amount is small compared to the depth of the global problem, IFC estimates the fund will have a leveraged impact of $75 billion as others co-invest in it, and the banks receiving capital would be able to lend to their clients at greater levels.
“It won’t solve all the world’s problems, but it gives a signal that we have enough faith--and so do other partners who participate with us--that the markets eventually will return. And if we handle things properly, we’ll actually have a huge developmental impact in keeping markets moving,” says Koskelo.
Recap Money Will Be Distributed Globally
Under the Recapitalization Fund’s “diversification requirements,” no more than 10 percent of the fund can go to any one bank, 20 percent to any one country, and 25 percent to any one region.
Banks don’t have to be in trouble to receive capital. The main objective is to provide capital to banks so they can continue to lend to businesses and individuals “who otherwise wouldn‘t have that money,” says IFC Recapitalization Fund team lead Flavio Guimaraes.
“This is not just replenishing capital that the banks have lost as much as it is helping to strengthen capital of banks so they feel confident to lend and are better prepared for further deterioration of economic conditions.”
The fund will support the most solid banks and also test the effectiveness of the response, adds the fund’s Europe-based team leader Jean-Marie Masse, a veteran of the IFC’s successful effort to aid Korean banks during the Asian financial crisis in the late 1990s.
“What we will try to do is have a demonstration effect. If it is well-crafted, then others will join us and increase the impact of what we do.”