THE URGENCY OF THE ANTI-CRISIS PROGRAM There are solutions, but the dangers are great

(Interview with Mihai Bogza, Chairman of Bancpost, Part I)

Reporter: Mister chairman, what are your forecasts for the year 2009, given the financial crisis? How affected will the banking sector be?

Mihai Bogza: There are many possible scenarios, but I believe that it would be prudent for Romanians to be ready for the worst. That is because of a very simple premise: last year, Romania had a current account deficit of 14% of its GDP, meaning some 15-16 billion euros. This means that various foreign factors - banks, companies who lent money to their Romanian branches, supplier credit and other such sources of funding - have provided Romania with funding which helped to a great extent fuel its remarkable economic growth in 2008.

The question is, how much longer can this growth be funded from outside sources in 2009? And as a corollary, how much will the Romanian economy have to adjust in order to cover the likely funding deficit? These are very important questions...

What seems to be obvious is that Romania will most likely no longer benefit from similar funding in 2009. There are several reasons for that, but they all stem from the risk aversion of the foreign investors, fuelled by a strongly negative perception on the recent economic developments. Let"s not forget that last year we have seen the disappearance of some famous banks, which were essentially giants, the "melting" of fortunes that Romanians can not even imagine, (the Merkle case), an INF like Ponzi-scheme which occurred in the US, which have one of the best watched financial systems in the world, (the Madoff case), the onset of recession in many Western countries, and even the bankruptcy of one of the most developed countries (Iceland). Which makes the fear that investors are feeling all over the world pretty understandable, just like their caution on Romania is to be expected. Let"s not forget that we are the only country in the EU that received "below investment grade" ratings from two rating agencies.

Under the pessimistic scenario that we were talking about, not only will external funding be dramatically reduced, but domestic banks won"t be able to take over this funding deficit, but rather they might even worsen the problems, by cutting down on lending.

Reporter: Why?

Mihai Bogza: After the first months of crisis, I see three reasons why this could happen.

The first is credit risk. In order to finance a client, you have to take on a credit risk which is far greater than it was last year. Given the uncertainty in the market at the moment, is there any company that can come up with a credible business plan, that a bank can study and finance? And is there anybody that can guarantee they will still have a job six months from now?

In order to understand how much the credit risk has changed, I want to mention that the so called CDS (Credit Default Swaps) for a 5-year term for the Romanian state now have a price of over 500 basis points, compared to a little over 100 basis points about one year ago. This means that potential lenders estimate that the risk of default of the Romanian state, which is a member of the European Union, let"s not forget, is more than 5%, and this 5% is included in the cost of the loan, in addition to other costs. And if the Romanian state is borrowing and paying a 5% premium from the start, just because it is perceived as having this risk factor, what risk spread should we, the banks charge our Romanian customers, either companies or natural persons? A far greater one, obviously, because the state is by far the most solvent entity. How much bigger? I won"t even try to answer that question...

The second factor is the liquidity risk. During the previous period, amid conditions of economic growth, banks weren"t too concerned with the liquidity risk. Most of them would give out foreign currency loans, for which they had long term financing sources, usually from the mother banks. Few loans would be given in lei, except for very short term loans, because the Romanian market has always been lacking long term sources of lei.

Right now, banks don"t know what currency to use for lending. Foreign currency has become dangerous because of the ever increasing fluctuations of the exchange rate, not to mention that funding from the mother-banks has become scarce. And the lei resources are mostly in the form of 1-3 months deposits. If based on these very short term resources one tries to grant loans with a maturity of 1-2 years, let alone those with a 5-10 year maturity, especially given the current volatility, the cost has to include a substantial spread, which would protect against certain jumps in interest - and during the last four months such jumps have been frequent.

And finally, the cost of resources has gone up. Right now all Romanian banks are paying a price for external resources that includes the country risk and which practically includes that margin that we were talking about earlier, of around 5%. This cost must be transferred over to the customers. And internally, the cost of resources has increased even more. Look at the cost of deposits, which has gone up by over 7-8% in the last year. In the similar period of 2008, banks would pay 6-7% interest on deposits, whereas now interest has gone up to as much as 14-15%.

Well, if we try to determine what the cost of loans should be in the current conditions if we take into account the elements above, we will get an interest rate that extremely few customers could afford to pay, especially given the current conditions. And then, is it any wonder that in October and November we have seen a shrinking of bank loans in real terms? And we were just at the beginning of the crisis...

Reporter: And what is the impact of lending reduction on the economy?

Mihai Bogza: Compounded with the shrinking of foreign non-bank lending, this could very likely turn the slowing economic growth into a great and lengthy recession. Without financial resources, not even viable companies, who have demand both on the domestic or foreign markets, can"t hold on for long. And in turn, banks, if they keep lending at negative levels, will see losses, because they won"t be able to afford massive investments they have made during these last few years. Long term, the banking sector can not survive without customers - not at its current size, anyway.

In other words, if things stay unchanged, that pessimistic scenario that I was talking about in the beginning could come true.

Reporter: Can that scenario, which I wouldn"t call pessimistic, but straight-out catastrophic, be avoided?

Mihai Bogza: Like all problems, this one must have a solution. In this case, the solution has to come in the shape of a complex program for supporting the economy. And for banks to resume lending, this program must efficiently address the three aforementioned elements.

Reporter: I think that both persons, as well as companies still have cash, but they are more cautious because of the crisis.

Mihai Bogza: To a certain extent that is true. But even if it is, after a while these resources will be exhausted. So if the economy does not recover quickly, and access to funding does not become available again, even very liquid companies are going to get in trouble, be it through the contamination effect if nothing else. If a liquid company makes and delivers some products, but its customers don"t have the resources to pay the products they received, it"s obvious what is going to happen.

Something similar could happen to natural persons. If we see massive layoffs, even people with savings will see them exhaust in time.

Reporter: So what should the economic program contain, from a bank"s point of view?

Mihai Bogza: Well first of all it should be very fast to appear, or else we run the risk of further downgrades by rating agencies, which would increase the country risk even further, with all the costs it entails. And it should be comprehensive and credible, to actually receive funding, - either from the EU, or from the IMF. And finally, it should be implemented urgently, before the problems which are already brewing in the economy get any deeper, making the solution even more difficult. You know the Romanian saying, "the longer the sickness, the more certain is death".