Where Does the EBRD Put its Money? – Interview with András Simor

The European Bank for Reconstruction and Development (EBRD) – an international financial institution located in London – invests in many opaque, at best, and not particularly democratic countries, for instance, of the former Soviet Union as it believes that this would contribute to greater democratization of those systems.

András Simor, the recently appointed Deputy Chief Financial Officer and Hungarian president of EBRD confirms in his interview to that the political and strategic interests of the United States and the European Union play an important role in the bank’s investment decisions. However, this may in no case result in senseless projects with unrecoverable costs. In fact, making money from the projects is their primary consideration. Right now, they might lose potential revenue from their biggest client as they are suspending all funding to Russian projects. András Simor, former central bank chief warns against the bubble risk in the current low-interest environment that is threatening both the Western world and Hungary.

Zentai Péter: Why do we still need the European Bank for Reconstruction and Development (EBRD)? It basically has the same function as the World Bank. Besides, the days, when helping the European (rather Eastern European) countries on the ashes of the Soviet empire was vitally important, are all gone.

András Simor: Let me get this straight: our goal is to support the development of market economies in democratic systems. Thus, unlike the World Bank or international development banks focusing on Asia, Africa and Latin America, we do not use financial instruments to fight poverty. I repeat, we invest in projects and lend money in order to advance democracy in Central and Eastern Europe; further to the East in Ukraine, Russia, Mongolia, and Turkey; in Central Asia in ex-Soviet republics; and even in four North African Arab countries, in Egypt, Tunis, Morocco, and Jordan.

So, that means that the shareholders of EBRD (the governments of sixty-something countries) are making profits?

We, who act in the name of market economy, would lack credibility if we did not apply the principles of market economy in our business policy, investments and stock purchases, if we ignored businesses with big financial gains, or if we did not operate profitably.

When financing a project in Hungary or in Ukraine or in any of the targeted countries, do you automatically acquire a holding in that business?

Not necessarily. It depends on the project. The important thing is that– whether we are involved as a shareholder or a lender – the investment has to be financially effective, competitive, and has to strengthen the market environment. Sometimes, we invest in government-owned enterprises but mainly, in the private sector.

Does the bank prosper? Have its investments of the last couple of years proved to be successful? What are you doing with the dividends and the profits?

The owners, shareholders – 64 states and 2 international institutions – have never taken profits out of the Bank. Dividends and profits are continuously reinvested. This is one of the reasons why the EBRD has an AAA credit rating, meaning that it is one of the most stable financial institutions in the world. So yes, we act like a “capitalist” in a sense that we realize profits, and eventually, we get out of the business, we sell our stocks. But it should be also noted that we never seek to achieve majority ownership, if we are co-owners in a business. The aim is to acquire so much stake that allows us to delegate directors and oversee the strategic decisions of the firm – but not full control.

Specifically, how much profit has the bank generated recently?

In both of the past two years, we made roughly one billion euro.  By comparison: this is the same amount the Hungarian bank sector was able to earn before 2008 financial crisis – in the years, when the country prospered the most. The 40-billion-euro portfolio of the bank is also similar to the total loan portfolio of the Hungarian banking industry. However, out of that, bad debts account for only 3 or 4 percent in the case of the EBRD, while they amount to 15 percent in Hungary.

Where can the EBRD earn the most?

Russia has been the biggest borrower so far – partly due to its size. We also invested – and earned, of course – significant amount of money in Turkey, Romania, Poland, Ukraine, and even in the much smaller Serbia. By industry, the financial sector seems to be largest but we are increasing our lending activity and stake in the energy sector, the agricultural sector, the infrastructural sector and other industrial sectors, as well. Our objective is to reduce the level of indebtedness in foreign currency, thus, we finance the projects in local currency. The EBRD needs resources from the capital markets and in some cases, from the central banks in order to lend it to others. In the fall, when I take over as Vice-President for Finance, I will oversee such operations. My job will cover fund raising, liquidity management, and supervision of bond issues, accounting, and financial planning.

How can the EBRD reconcile its mission with the fact that Turkey Russian and other opaque states like Tajikistan, Uzbekistan, Kazakhstan, and most of the ex-Soviet republics became its major partners?

The important thing for the EBRD is not the current political status but the economic dynamics of the countries. Irrespective of the internal affairs of Turkey, its economy has been commercializing for 15 years. It has become a diverse and strong national economy, where both domestic and international investors can feel safe.
With regard to the ex- Soviet republics, we also measure their development and development potential relative to their former state – as we do in the case of Central European countries.
On that basis, the EBRD feels that it is important to show the way to market economy in Central Asia, even though the political system of most of these countries is very far from mature democracy. The question is where they are heading and whether we can facilitate the process.

Although the domestic investors in those countries pretend to be independent, they are very closely linked to the government, in many cases to the head of the state and their family members.

We are not allowed to participate in projects where state officials, rulers, or their family members are certainly or supposedly involved. We always try to make that clear from the start. At the same time, the more dominant our presence in the region is, the more likely it is that corruption, bureaucracy, and the power of the government is reduced. The presence of the EBRD encourages independent foreign investors to enter those markets. And the higher the number of real market players in the country, the more transparent and fairer the market economy becomes and, indirectly, the more democratic the whole society becomes.

These countries are large raw material producers and exporters. What political and economic interests are lurking behind your increasing presence in Central Asia? Maybe that the United States and the European Union want to isolate these states from Russia?

I do not deny that the investment decisions of the EBRD are influenced by high politics. This can also be seen in our decision-making body, which consists of the largest shareholders (including the member states of the EU and the United States). They ensure most strictly that the EBRD continues to support the development of democracy and a more transparent, free market. This is politics in itself.

That is the reason why the EBRD suspended funding to Russian projects, even though Russia has been a very profitable market for years… So now you have to sacrifice significant profits for politics?

It is true that the European Council (the deliberative body of the heads of state or government of EU member states) asked the EU-representative directors delegated to the EBRD to discuss the lending by the Bank to Russia. As a result, the majority of the board decided not to initiate new projects in Russia. At the same time, the Ukrainian projects are priorities as our shareholders wish to support the democratization and the opening up of the market. Whether there are enough interesting projects in Ukraine due to its complex internal situation is another question. Nevertheless, we approved half-billion dollars of investment in Ukraine.

More specifically, how much is at stake in Russia from the perspective of the EBRD?

In the first half of the year, we invested roughly 700 million euros in Russian projects. The Russian market accounts for as much as 22-23 percent of the whole portfolio of the Bank – that is altogether 38 billion euros. So, Russia is an 8-9-billion-euro investment portfolio for the EBRD.

A recent study of the EBRD’s economic research department pondered whether the globalization of the banking sector in Central and Eastern Europe was right or not. In Hungary, it is also a hot topic whether we are happy with foreign banks having 60% share in the industry. Why did the EBRD address this issue?

It was about time to analyze the lessons of the fading international financial crisis. It is already clear that the banks should rely more on deposits than capital market funding. The latter may be an additional income but the main financing source should be the deposits. In the economic crisis, the – sometimes very risky – capital market resources evaporated. Probably, this would not have happened if the banks had been financed by deposits of companies and individuals.

What is the outcome of the report: is it beneficial or harmful if foreign banks have more than 50% market share in a country?  

There is no clear response to this question. The issue can be examined both through the perspective of financial stability and sustainable economic growth. From the point of view of financial stability, in a local crisis, foreign banks might be very useful, if they recapitalize their subsidiaries. They remove a lot of the burden from the shoulders of the state, the government.  However, in a global crisis, the negative international financial have a stronger impact through foreign owned banks than domestic financial institutions. In this sense, the national ownership provides greater protection. At the same time, foreign savings, financial resources and more advanced financial technologies played a significant role in the economic growth of many countries – mainly, due to the lack of domestic savings.

What clearly emerges from the crisis is, however, that the behavior of the banks is rather determined by the macroeconomic fundamentals of the country than the ownership compositions. While foreign banks hardly withdrew resources from the Czech Republic, which is almost free of net debt, they took out a lot of money from the heavily indebted Hungary. This applies even when we consider that in the acute period of the crisis, foreign owners imported more than they exported. The process has now reversed: more money is leaving than flowing into the country through foreign-owned banks. At the same time, while lending activities have recovered in the Czech Republic – and in a broader sense, in whole Central and Eastern Europe -, Hungarian banks provide fewer loans as they are not willing to take high risk.

There is one further aspect: the Hungarian banking sector is 60 percent foreign-owned. This percentage is way higher among the eight new EU member states: in the rest of the Visegrad Group, it is above 80 percent. Still, the most bank capital flew out from our country. In the region, Slovenia was hit most severely by the local bank crisis, although they have the lowest share of foreign ownership. It turned out that the semi- or fully government-controlled banks were not lending on a commercial basis but on a political basis. In the end, their bank sector almost collapsed and the government and the tax payers had to make great sacrifices to save it. Despite that, there are many Western countries, where state financial institutes are transparent and operate on a commercial basis. However, if we look at Hungary, the fully government-owned Hungarian Development Bank has generated huge losses in the past two decades.

I believe I can say that the lower the chance that the state intervenes as an owner – not only in the bank sector but the whole economy –, the more effective the business economy at corporate and national level. Assuming, of course, that the state plays an active role in regulating the market and controlling monopolies. It is proven again and again that if the state or its representatives robostfully step in as owners or investors, business and shareholder interests at risk of being marginalized – and instead, political interests are put first. As a result, economic performance weakens sooner or later. Nevertheless, the state can and even should play a strong and effective role of regulator in the economy.

So you are saying that banks should be strengthened from the side of deposits because the past years’ events have proven that excessive financing from capital markets might lead to dramatic situations. But why would companies and individuals keep their savings in such a zero-interest-rate environment? This environment encourages risk taking not playing safe.

No one can argue that the global financial crisis was caused by debt: either the state or the bank sector or the population was in extreme debt. It is also clear that the low interest rates encourage investors to fall into more debt. On the other hand, they may help the economy recover and grow and create new jobs. So there is a fundamental contradiction regarding the current global interest rate environment.
Personally, I am convinced that in order to resolve this dilemma, the countries should focus on increasing competitiveness, liberalizing labor market, innovation and reducing bureaucracy rather than low interest rates.
The current interest rates do not lead to inflation – at least, so far. But they can certainly lead to real estate or stock market bubbles.
More and more signs suggest that the world of zero-interest-rate environment will disappear. If we want to achieve an inflation of 2 percent in all of the leading capitalist countries, we will have to gradually increase the base rate. This must have an effect on Hungary, too.

The latest GDP data in Hungary implies significant economic recovery. Does that mean that the unprecedentedly low level of interest rate benefits our economy?

Clearly, low interest rates can stimulate economic growth. I note that what matters is the real interest rate, not the nominal interest rate. With zero inflation, a 2-percent base rate means the same 2-percent real interest rate as a 7-percent base rate with 5-percent inflation. To respond to your question, the important thing is what lies behind the outstanding GDP data.

First, only time will tell whether short-term or long-term growth has started. For more than six years, private consumption has decreased in Hungary. This dramatic set-back – mainly, caused by the credit crisis – has led to a point where people can finally get on their feet again and consumption can rise. At the same time, the car industry and the construction industry also boosted the GDP.

Second, the domestic growth needs to be placed in an international context. In this sense, it is not clear yet whether we are part of a dynamic, international growth trend or our performance is outstanding. Here, in England, they also forecast a growth of 3 percent for the year – in other words, a richer country can produce similarly positive results. However, France and Germany will publish very poor GDP data; compared to them, the Hungarian performance is truly outstanding.