This Selected Issues paper focuses on the medium-term budgetary framework (MTBF) for Austria. Austria is part of a trend among many countries to consider some form of MTBF. This paper describes the proposed framework in Austria and assesses it in light of the experience of other countries. The general conclusion is that the track records are mixed, but that, on balance, the experiences with MTBFs have been favorable. The paper also examines the long-term fiscal challenges arising from demographic change.

Abstract

This Selected Issues paper focuses on the medium-term budgetary framework (MTBF) for Austria. Austria is part of a trend among many countries to consider some form of MTBF. This paper describes the proposed framework in Austria and assesses it in light of the experience of other countries. The general conclusion is that the track records are mixed, but that, on balance, the experiences with MTBFs have been favorable. The paper also examines the long-term fiscal challenges arising from demographic change.

III. Cross-Border Banking Issues for the Austrian Banks and Their Supervisors 26

A. Introduction

51. Austrian banks play a major role in many countries in Central, Eastern, and Southeastern Europe (CESE). Almost all of the large Austrian banking groups have subsidiaries in several countries in CESE. In quite a few cases, these subsidiaries are large compared with the host country’s financial systems. Moreover, some of these subsidiaries would probably be judged to be of systemic importance to the financial systems in the host countries. At the same time, the holdings in the CESE are important for the Austrian banks, as they represent a significant part of total assets and provide a major contribution to overall profitability.

52. This chapter focuses on the challenges associated with the activities of the Austrian banks in CESE. The paper will briefly discuss the structure of the Austrian banking sector in Section B. It will then discuss the successful expansion of the Austrian banks into CESE in Section C, before focusing on the challenges going forward for the banking system (Section D) and its supervision (Section E). In particular, these challenges stem from (i) the pressure to keep up profitability; (ii) the rapid expansion, with which risk measurement and management have to keep in line; and (iii) the current supervisory, regulatory, and crisis management structure, which has generally not been designed to deal with banking groups that are potentially of systemic importance in several countries.

B. The Austrian Banking Sector

53. The Austrian financial system is dominated by the banking sector.27 At roughly 300 percent of GDP, total banking sector assets are far larger than those of insurance companies and pension funds (Table 1). Mutual fund assets and stock market valuation have increased considerably over the last five years, but also remain small compared with the banking sector. Domestic credit provided by Austrian banks is in line with levels elsewhere in Europe.

Table 1.

Austria: Main Components of the Financial Sector 1/

(At end-2005)

article image
Sources: Austrian National Bank; and International Financial Statistics.

Series are not strictly comparable owing to differences in definition and time period.

From IFS banking survey (national residency).

Converted using year-average exchange rates.

54. The banking sector has a multipillar, tiered structure. There are seven pillars or categories of banks: joint stock and private banks or commercial banks (Aktienbanken), savings banks (Sparkassen), rural credit cooperatives (Raiffeisenbanken), industrial credit cooperatives (Volksbanken), provincial or state mortgage banks (Landeshypothekenbanken), building societies or savings and loans associations (Bausparkassen), and special purpose banks (Sonderbanken) (Table 2). Three of the sectors—the savings banks, Raiffeisen banks, and Volksbanks—have tiered structures, with apex or central institutions at the topmost tier providing centralized services, such as liquidity management and risk assessment, to the other institutions in the sector.

Table 2.

Austria: Size of the Banking Sector, December 2006

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Source: Austrian National Bank.

Includes severance funds, investment companies, and real estate funds.

Foreign bank branches pursuant to Article 9 of Austrian Banking Act.

55. Despite a period of continued consolidation and restructuring since the early 1990s, bank and branch densities remain among the highest in Europe. Over the last decade, the number of credit institutions and the number of branches have both decreased, leading to a substantial reduction in branch density. However, density remains on par with densely branched countries like Germany and Italy (Figure 1).

Figure 1.
Figure 1.

Bank Branch Density

Citation: IMF Staff Country Reports 2007, 143; 10.5089/9781451802382.002.A003

Sources: European Central Bank; and IMF, IFS.

56. The efficiency of the banking sector has increased over the past few years, but cost-to-income ratios remain high. Returns on assets have gradually improved over the last 15 years. Since about 5 years ago, this development has gone hand in hand with major improvements in efficiency, as reflected by decreasing cost-to-income ratios (Table 3). Nevertheless, these ratios remain above the average of Austria’s European peers, partly reflecting the structure of the banking sector.

Table 3.

Austria and Other European Countries: Selected Banking Sector Performance Indicators, 1992-2005

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Sources: Organization for Economic Cooperation and Development (OECD); and European Central Bank (ECB).

OECD data. All banks, except where noted.

ECB data. All banks, consolidated.

For 1992 and 2001, only figures for commercial banks are available.

C. Austrian Banks in CESE

57. In the early 1990s, Austrian banks were among the first to enter the Central and Eastern European (CEE) market. During that period, driven by geographical proximity, historical ties, and a saturated domestic market, most of the larger Austrian banks moved into the region. Generally, expansion started in Hungary and (then) Czechoslovakia. From there on, expansion continued, and currently comprises virtually all CEE markets.

58. More recently, Austrian banks have entered Southeastern Europe and the CIS. Between 2003 and 2005, their expansion led to increases in domestic market shares in almost all of CESE, with the increases in Romania and Bosnia and Herzegovina especially large (Figure 2). Some Austrian banks have expanded further east by entering the market in some of the CIS countries, most notably in Russia and Ukraine.

Figure 2.
Figure 2.

Domestic Market Shares of Austrian-Owned Subsidiaries in CESE

(Percent)

Citation: IMF Staff Country Reports 2007, 143; 10.5089/9781451802382.002.A003

Source: BankScope.

59. As a consequence, Austrian banks now own subsidiaries that are of key importance in several of the host countries in CESE. Even though Austrian banks are not large by international standards, their CESE subsidiaries are of considerable size. As the host countries are emerging markets, their financial systems are generally small by international comparison, and their financial markets are still deepening. As a consequence, some of the Austrian-owned subsidiaries are large in relation to the size of the financial systems of the host countries and could be considered of systemic importance.

60. The Austrian activities in the CESE are also of primary importance for the Austrian banking system, as they constitute a significant share of total assets. Austrian exposures to the CESE are far Figure 3. Consolidated Foreign Exposure to CESE, 2005 larger (relative to GDP) than those of its European peers (Figure 3), even though total consolidated foreign exposures (i.e., to all other countries, relative to GDP) rank only as moderately high compared with those same peers. In 2005, the total assets of the five largest Austrian banks in CESE amounted to some €136 billion, or around 16 percent of total assets. Most subsidiaries are majority owned, with around €130 billion of assets among them (Table 4).

Figure 3.
Figure 3.

Consolidated Foreign Exposure to CESE, 2005

(Percent of GDP)

Citation: IMF Staff Country Reports 2007, 143; 10.5089/9781451802382.002.A003

Source: Bank for International Settlements.
Table 4:

Majority-owned Subsidiaries of Austrian Banks in CESE, 2005 1/

(Millions of euros)

article image
Source: Bankscope.

Ownership of 50 percent and above.

61. Moreover, the activities in CESE contribute significantly to overall profitability. Domestic profitability of the Austrian banks, although improved in recent years, is low compared to its European counterparts. Overall profitability has been kept up in large part due to the profit contribution of the banks’ subsidiaries in CESE. In 2005, activities in that region contributed some 35 percent of pretax profits of all Austrian banks (Austrian National Bank, 2006).

62. The profitability of the operations in the CESE is driven by the rapid credit growth in these countries. Credit growth has been high and continues at a rapid pace in most countries in CESE (see, e.g., Cottarelli, Dell’Ariccia, and Vladkova-Hollar, 2003). To a large extent, this reflects financial market development and deepening in these countries. However, the high growth rate of private sector credit has contributed to challenges in the assessment of credit risk (Hilbers and others, 2005, and Schadler and others, 2005), and in some cases, to macroeconomic imbalances in the form of large current account deficits (Lane and Milesi-Ferretti, 2006). At the same time, the strong demand for credit has enabled the banks to lend at relatively large margins.

D. Challenges for the Banks Going Forward

63. The operating margins in CESE may come under strain in the next few years. The presumption of continuing large profits builds on expectations of ongoing high economic growth, catch-up in the level of financial intermediation, and wide lending margins. As the financial markets in CESE develop, credit growth may start to slow. Some studies indicates that, indeed, some countries in the region, and in particular in CEE, have come close to their equilibrium level of private credit to GDP, and some risk of overshooting exists (Backé, Egert, and Zumer, 2006). Moreover, the development of financial markets may affect profits more directly by increasing competition and, hence, narrowing margins. Indeed, banks’ interest rate margins in CEE have exhibited a declining trend for some years now (Figure 4). Margins could come under further strain if expectations for economic growth in the region and the concomitant level of financial intermediation turn out to have been too optimistic.

Figure 4.
Figure 4.

Net Interest Margins 1/

(Percent)

Citation: IMF Staff Country Reports 2007, 143; 10.5089/9781451802382.002.A003

Sources: BankScope; Organization for Economic Cooperation and Development.1/ Net interest income divided by total assets.2/ All banks in country, simple average over countries.3/ All banks, consolidated basis.

64. Operations in CESE entail a number of other risks as well (Breyer, 2004). First, various countries in the region exhibit considerable macroeconomic imbalances. While such imbalances to a certain extent reflect a catch-up process, they may be excessive in some cases and, hence, increase the potential for a sharp reversal. Second, operations in the region have to cope with exchange rate volatility, which, in some cases, has been considerable. Moreover, as the planned dates for EMU accession tend to be postponed throughout the region, exchange rate risks will be around for some time to come. Third, in an environment with rapid credit growth, partial or nonexistent credit histories, and limited experience in credit screening, enforcing proper credit risk standards may be difficult. Lastly, political and legal risks and uncertainties remain in parts of CESE.

65. Lending in foreign exchange to households adds to the banks’ risks. This practice is prevalent both domestically in Austria, and in the countries in CESE. In Austria, foreign exchange credit is monitored, and efforts at consumer education have been undertaken.28 In CESE, in contrast, such monitoring of foreign exchange credits is less well developed, and consumer awareness of the associated risks is likely lower.29 Moreover, the number of households in these countries having a natural hedge in the form of foreign exchange income is limited. Although the banks generally apply prudent lending standards to foreign exchange credits, large exchange rate movements may cause the foreign exchange risks for the households to translate into credit risks for the banks. Even though the banks carefully monitor and manage their open positions in foreign exchange, this does not isolate them from credit risk associated with foreign exchange loans.

66. Two important challenges for the Austrian banks looking ahead are:

  • First, to preserve high profitability. To maintain profitability, the banks can focus on revenues, costs, or both. In CESE, although there is some scope for efficiency gains and for an increase in noninterest income, maintaining profitability against the background of declining interest rate margins would primarily require increasing exposures. The banks can do this by increasing risk exposure in countries where they are already present (and where margins are still higher than domestically), by, e.g., moving more funds into profitable retail lending. Alternatively, they can expand their operations to countries where they are not yet present. In particular, many countries further to the east and southeast feature less developed financial systems and potentially larger margins (see, e.g., EBRD, 2006). However, increased exposure to these countries would also increase risk. Expansion into other, more sophisticated international markets, however, also entails risks, for instance when such expansion leads to exposure to complicated and volatile derivative products. On the costs side, adjustments can be made in the short to medium term. In the domestic banking market, in particular, there seems to be further scope for efficiency gains, which could involve further consolidation. Another leap in efficiency could possibly be achieved by further integrating the operations in different countries.

  • Second, to keep risk management and measurement techniques in line with rapid market developments. The expansion associated with maintaining profitability could increase risks. To manage such risks well, the banks need up-to-date risk measurement and management systems. In addition, to strike a balance between profits and risks, the organizational structure of the banks needs to ensure that risk management considerations are dealt with at the management level. In this context it is also important to note that improved risk management, in particular underwriting practices, leads to lower NPLs, which translate into a more profitable bottom line.

E. Implications for Supervision

67. The challenges for the Austrian supervisors are closely related to these issues:

  • First, the rapidly expanding activities of the financial sector require close monitoring. As argued above, the expansion in CESE has helped financial deepening in this region, but the risks involved have grown with the expansion of the activities. In addition, and in preparation for the implementation of Basel II, supervisors need to continue to ensure that the banks use appropriate and adequate risk management and measurement techniques. Specifically, the issue of intragroup risk and capital transfers warrants supervisory attention. Furthermore, it will be important to assess the macroprudential risks associated with the potential impact of macro vulnerabilities (at both national and regional levels) on the banking system, including through stress testing.

  • Second, close collaboration between the Austrian and the host supervisors in CESE is key to effective supervision of cross-border banking groups. The enlargement of the EU has facilitated cross-border supervisory cooperation with the new member states; particularly useful has been the signing of memoranda of understanding (MoUs) between home and host supervisors regarding exchange of information and cross-border supervisory cooperation with these new member states. Intensifying such supervisory cooperation will remain imperative. In addition, it will remain important to deepen cross-border supervisory cooperation with non-EU member states in which the Austrian financial sector has a significant market share, including the negotiation of MoUs.

68. In response to these supervisory challenges, the FMA and the ANB have devoted considerable attention to home-host supervisory issues. A large number of MoUs on supervisory cooperation have been signed, and an active dialogue with foreign supervisors with whom no MoU has been signed (yet) is maintained; this dialogue includes the organization of conferences with, and training sessions for, supervisory authorities in CESE, and the development of a regional supervisory strategy. Interestingly, in this host-home cooperation, the Austrian supervisory authorities fulfill the role of home as well as host supervisor: they are home supervisors for the various subsidiaries in CESE, while at the same time, they function as host supervisor for one of the large Austrian banks owned by a foreign group.

69. The authorities have concluded many bilateral MoUs on supervisory issues with foreign counterparts. MoUs have been concluded with counterparts in (in chronological order) France, the Netherlands, the U.K., Italy, Germany, Hungary, Slovenia, the Czech Republic, the Slovak Republic, Croatia, Bulgaria, and Romania. Negotiations to conclude MoUs with Malta, Poland, and Cyprus are ongoing, whereas discussions with regard to possible future MoUs are being held with authorities from Ukraine, Russia, Albania, and Serbia. These memoranda center on information exchange and examination rights, and stipulate the confidential treatment of information exchanged between the supervisors. They, hence, serve as a basis for a structured and regular exchange of information.30

70. In addition, the Austrian authorities are signatories of the multilateral EU MoUs on cooperation in financial crisis situations (Box 1). These MoUs, one between banking supervisors and central banks, and one involving banking supervisors, central banks, and finance ministries, primarily arrange for the exchange of information in a crisis situation. They were drafted after the two Brouwer reports on financial stability and crisis management (Economic and Financial Committee, 2000 and 2001) highlighted the need for arrangements additional to the existing EU framework.

71. While the existing cross-border supervisory arrangements provide a framework for further supervisory cooperation, gaps remain. The current EU cross-border supervisory framework has not been designed specifically to deal with banking groups that are potentially of systemic importance in several (home and host) countries. In particular, for financial institutions with potentially systemically important operations in one or more host countries, issues can develop between home country lead responsibility for supervision and host country responsibility for financial stability. In addition, the framework for cross-border crisis management remains very much a work in progress (De Nicoló and others, 2005).

72. To address these issues, the Austrian authorities are increasingly involving their foreign peers in risk assessments of the cross-border activities of Austrian banks. Currently, the Austrian authorities and their peers in CESE are staging simultaneous inspections at the subsidiaries of one large Austrian bank. Such preparations for joint risk assessments with their foreign peers signify an important step. If successful, this step could be expanded by formally introducing joint risk assessments for all the large cross-border groups, which could then lead to a joint supervisory plan for the group. In addition, against the background of Austrian banks’ relatively large exposure to CESE, the Austrian authorities could consider, in due course, conducting joint cross-border crisis management exercises with their counterparts in CESE, in order to assess the current framework for cross- border crisis management.

Austria: The EU Framework for Cross-Border Supervision, Regulation, and Crisis Management

Cross-border arrangements consisting of a broad range of Financial Services Directives are embedded in the EU framework. These directives are binding legislation. The current EU framework has evolved from the 1989 Second Banking Directive (89/646/EEC), which introduced the principle of home country control in supervision.

In the current EU supervisory arrangements two directives stand out:

  • The Capital Requirements Directive (CRD, 2006/48/EC and 2006/49/EC) establishes the Basel II capital requirements in European legislation, and introduces a central role for the consolidating or home supervisor in cross-border supervision. In particular, the CRD gives the consolidating supervisors the power to approve a banks’ internal risk models when a joint decision with the host cannot be reached. The CRD also strengthens and clarifies the requirements for information sharing and cooperation among all authorities responsible for the supervision of group entities.

  • The Financial Conglomerates Directive (FCD, 2002/87/EC) introduces a single coordinating supervisor for financial conglomerates. This way, oversight of, and interaction with, centralized financial conglomerates should be facilitated. A key provision is Article 10, which introduces a coordinator at the group level overseeing the capital adequacy and risk management. The challenge for this single supervisor is to adopt an integrated (that is, banking and insurance) perspective at the group level instead of a sector perspective.

Recognizing potential gaps in the general framework described above, supervisors, central banks, and ministries of finance have concluded several MoUs at the European level aimed at facilitating informational exchange. These MoUs were drafted after the two Brouwer reports on financial stability and crisis management (Economic and Financial Committee, 2000 and 2001) highlighted the need for additional arrangements. The MoUs (one on high-level principles of cooperation among banking supervisors and central banks, and one on cooperation between banking supervisors, central banks, and finance ministries) sketch a general framework for informational exchange both in normal times as well as during a crisis. As such, they mark an important step forward in EU coordination.

Some European supervisors have gone further in bilateral and regional MoUs. The most detailed examples are the MoUs between the Nordic supervisors and the MoU between the Belgian and Dutch supervisors regarding the treatment of individual cross-border operating banks. These MoUs provide modalities for joint risk assessments and supervision. In addition, the Nordic central banks have concluded an MoU on emergency liquidity assistance in case of crises in cross-border banks.

F. Concluding Remarks

73. The Austrian banks’ cross-border activities present several important challenges. Exposure of the major Austrian banks to CESE is large, as the Austrian banks own a major part of the domestic banking system in many countries in the region and derive a large share of their profits from those countries. This exposure and ownership results in several challenges for the banks, stemming from (i) the pressure to keep up profitability and, (ii) the rapid expansion, including in foreign exchange lending, with which risk measurement and management have to keep pace.

74. The banks’ international expansion also has important implications for the supervisory process. First, the rapidly expanding activities of the financial sector require close monitoring, as the risks involved are growing with the expansion of the activities. Supervisors need to continue to ensure that banks use adequate risk management techniques, also in preparation for Basel II. Second, close collaboration between the Austrian and the host supervisors in CESE is key to effective supervision of cross-border banking groups; such collaboration would also be important for managing a potential problem in a large cross-border bank. Austria is one of the EU countries that has most to gain from a good cross-border supervisory framework, and the current window of a stable domestic economic environment and solid economic growth, both domestically and in most of CESE, presents a good opportunity to further improve and deepen the cross-border supervisory, regulatory, and crisis management framework. This collaboration should extend to supervisors in both EU and non-EU member states, and include the negotiation of MoUs.

References

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26

Prepared by Alexander Tieman (MCM). This section provides background information and analysis in support of paragraphs 23-27 and 37-39 of the Austria Staff Report.

27

For an assessment of the Austrian financial sector conducted in 2003-04 in the context of the Financial Sector Assessment Program (FSAP), see IMF (2004). An FSAP update is tentatively planned for the second half of 2007.

28

See for instance the brochure aimed at consumer education on foreign exchange lending, published jointly by the Austrian National Bank (ANB) and the Financial Market Authority (FMA) (Financial Market Authority 2006). In addition, the FMA has mandated minimum standards on granting and managing foreign currency loans (Financial Market Authority, 2003).

29

In addition, such limited awareness could contribute to the risk of herd behavior; see Tzanninis (2005).

30

For some countries where MoU discussions are at an advanced stage but have not been concluded, a similar structured and regular exchange of information takes place.

Austria: Selected Issues
Author: International Monetary Fund