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LONDON - Banks are likely to keep cutting lending to central and eastern Europe this year, under pressure from an asset review and emerging market tensions, according to a group set up to avert a capital drain from the region.
A new report by the International Monetary Fund and other 'Vienna Initiative' institutions showed that market volatility and global borrowing costs meant Western banks had further scaled back positions in emerging Europe between June and September last year.
The cut was the same as the previous quarter and worth 0.2 percent of the region's gross domestic product (GDP), though the steady figure will help alleviate worries that the Federal Reserve's stimulus withdrawal plans could be accelerating the retrenchment.
Since 2008, the cumulative deleveraging by big banks equates to almost 10 percent of the region's GDP, if Turkey and Russia are excluded from calculations and is a trend that is expected to continue.
"With global liquidity starting to tighten, the concern is that this may precipitate a further reduction in (banks') exposure and that may be at a more rapid pace in the last few years," Aasim Husain, deputy director at the IMF's European Department, told reporters in a conference call.
"Acceleration in the pace of deleveraging hasn't happened but we are not out of the woods yet."
The report was compiled by the steering committee of the Vienna Initiative, a coordinated effort by banks, international financial institutions and policymakers to avert a disorderly withdrawal of capital from the region.
Emerging Europe enjoyed large foreign capital inflows in the boom years before the start of the global financial crisis in 2008. Now some is being pulled back.
The European Central Bank is due to publish the results of its health-check on banks in late October and its data shows a sharp drop in the size of balance sheets at the end of last year, as banks got themselves in shape for the tests.
"The ongoing deleveraging and de-risking of the European banks' balance sheets will likely continue and may intensify amid the euro area AQR/stress tests, leading to further tightening of credit supply for (emerging Europe), especially for countries with weaker fundamentals and growth prospects," the report said.
The report showed Slovenia, Hungary and Croatia experienced the largest reductions in foreign bank funding in Q3 while credit growth all but seized up in central, eastern and south eastern Europe (CESEE), not including Russia and Turkey.
On the demand side, while household credit demand was improving in countries like Poland, demand from large companies remained weak, reflecting depressed capital expenditures.
"The latest available bank balance sheet data (Q1-Q3 2013) for selected CESEE subsidiaries of foreign banks show notably weaker profitability in Hungary, Slovenia, and Ukraine than in other countries in the region," the report said.
"Despite some growth pick-up in the third quarter of 2013, recovery in many CESEE countries outside CIS (Russia) and Turkey remains creditless and mainly driven by net exports," it added.
(Additional reporting by Sujata Rao; Editing by Ruth Pitchford)
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