Retail lending to remain the main driver of volumes growth, with good macroeconomic prospects supporting a favourable corporate lending performance

Two-thirds of the banking industry in CEE owned by international banks in “established” CEE markets

New opportunities arising from a widening of the perspective, in terms of single markets (Russia, Turkey and Ukraine) or in terms of global growth strategies of the players involved (such as UniCredit / HVB)

The banking market in Central and Eastern Europe (CEE) continues to be dominated by international banks, which consider the region as a second home market with strong growth potential. At the end of 2005, international banks' market share was 78 per cent (excluding Russia, Ukraine and Turkey). With 76% market share in terms of assets, controlled by international banks, Bulgaria is at the golden mean of this indicator. This is the result of a recent study conducted by UniCredit New Europe Research Network – the research network including all the research departments of the Group focused on the CEE region.

"The banking market in Central and Eastern Europe will continue to grow strongly. As the region offers large potential for business, this market will remain a focus of attention of international players. CEE is a core market for UniCredit Group. We will take advantage of the strong momentum of the CEE banking market and will continue to grow with it," says Andrea Moneta, Member of the UniCredit Management Committee.

Retail loans are driving growth with good macro prospects supporting a favourable corporate lending performance.

The main driver for volume growth in the region will continue to be retail lending. Retail loans in Central and Eastern Europe as a whole are expected to grow at an annual average rate of about 31 per cent until 2008. The strongest increase will be seen in Russia, where this sector will grow by 56 per cent, almost double the rate achieved by the CEE market as a whole (including Russia).

"We think that retail lending business will triple over the next three years. At present 51 per cent of the potential Russian users of banking goods and services hold a bank account. This figure indicates the enormous potential available," says Debora Revoltella, UniCredit CEE Chief Economist. Russia is followed by Serbia and Turkey, where retail loans are expected to grow by above 30 per cent annually. The retail loans in Bulgaria are expected to grow at a much moderate pace of about 21% on average annually for the period till 2008.

At 24 per cent, average annual growth of lending volume in the entire CEE region is much stronger than in the euro area (6 per cent). Data for individual countries as at year-end 2005 show that the total volume of loans, expressed as a percentage of GDP, was highest in Croatia with 68 per cent, far above the CEE average of 32 per cent . In Romania, the comparative figure was 22 per cent, indicating the potential available in the market. In Bulgaria as of end 2005 loans to GDP is about 43% with a tendency to reach 50% by 2008. Generally speaking, throughout the region, we expect lending growth to continue to be supported by a combination of strong economic growth and a remaining gap in terms of market penetration (loans and deposits as % of GDP). Good macroeconomic prospects and strong investment demand will support a favourable corporate lending performance. The corporate lending in Bulgaria is expected to grow on average with 13% p.a. for the period 2005-2008.

The deposits in the region are expected to grow at a relatively stable pace (P8, P9 and P10 from the presentation), but with different patterns among the countries. The expected good profitability of the corporate sector will sustain the growth in deposits’ volumes with retail playing a significant role in Russia, Romania, Bulgaria, Serbia, Bosnia and Turkey. The retail deposits growth will be 16% p.a. for the period 2005-2008 in Bulgaria. A 14% average growth p.a. is expected also in corporate deposits in the country for the same period.

The banking markets in "established" CEE countries have been privatised to a large extent and now offer very few opportunities for major acquisitions. Therefore international investors are increasingly turning their attention to markets such as Russia, Turkey and in the mid-term also Ukraine, where the process of internationalisation and consolidation has not yet reached an advanced stage. These countries offer significant growth potential: if they are included in the market share calculation, international banks account for only 46 per cent of the CEE banking market.

In Turkey, international banks currently have a market share of 19 per cent. The privatisation process is advancing, while further market consolidation should also be expected. Foreign banks’ market share in Russia is even lower, at currently 9 per cent, and, with a total of 1,200 banking institutions, a process of structural transformation is clearly in place. The highest concentration of international banks is to be found in the new EU member states Estonia (99 per cent) and Slovakia (98 per cent), followed by Croatia (91 per cent), an EU candidate country

1 CEE = Bosnia and Herzegovina, Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Russia, Serbia, Slovakia, Slovenia, Turkey, Ukraine.

“Russia, Turkey and in the mid-term also Ukraine are clearly the new frontiers of a regional strategy for international players active in the region. Still, on a more general perspective, we expect the consolidation process at the international level to become another significant driver for structural transformation in the region, like in the case of the UniCredit-HVB merger, which created by far the largest player at the regional level and led to a renewed process of consolidation at the individual level,” says Andrea Moneta.

The leading international banks in CEE

A few international players consider the region as a second home market. Such international players are among the top players in several countries of the region and profit from a widespread cross-regional network. The top 7 players control about one quarter of the entire banking market in Central and Eastern Europe (26 per cent, measured by total assets).

Among the largest international banks operating in the region, UniCredit Group ranks first, with total assets of EUR 86.2 billion1 and net income after taxes (before minority interests) of EUR 1.3 billion1. This means that UniCredit Group is almost twice as large as the nearest competitor. Erste Bank is in second place, with total assets of EUR 48.7 billion2 and net income after taxes (before minority interests) of EUR 711 million2. KBC of Belgium ranks third, with total assets of EUR 42.7 billion and net income after taxes (before minority interests) of EUR 556 million.

Ranking behind the three leading banking groups are Raiffeisen International (total assets: EUR 42.3 billion3, net income after taxes: EUR 481 million), Société Générale (total assets: EUR 30.1 billion4, net income after taxes: EUR 531 million), Banca Intesa (total assets: EUR 22.1 billion, net income after taxes: EUR 326 million) and Hungary's OTP6 (total assets: EUR 19.1 billion, net income after taxes: EUR 609 million). The largest networks are those of UniCredit Group / BA-CA (17 countries) and Raiffeisen International (15 countries), followed by Société Générale (10 countries) and Banca Intesa (9 countries).

“It is interesting to note that among the 7 top regional players, only 3 are among the top 20 European banks market capitalisation. This confirms our idea that the international process of consolidation can bring further structural transformation at the regional level”, says Debora Revoltella, UniCredit CEE Chief Economist.

Four out of seven of the biggest international groups in the region own majority stakes in Bulgarian banks. These are UniCredit, RZB, SocGen and OTP.

Improvement of bank efficiency and profitability remains high

The banking market in Central and Eastern Europe will continue to be a key growth market for international banks operating in the region. In 2005 alone, the combined net income before taxes of banks in the CEE-9 countries1 rose by EUR 4.5 billion, from EUR 16.5 billion in 2004 to EUR 21 billion in 2005. UniCredit Group's experts think that due to factors like growth in business volumes, costs optimisation and improved risk management the profits in the region will double to about EUR 32 billion from 2004 to 2008. For the period 2005-2008, this translates into annual growth of 15.2 per cent (P11 from the attached presentation). Close to that number is the expected increase in profitability of the EU candidate countries as Bulgaria and Romania. According to UniCredit the compound average growth rate of the net profits in Bulgaria for the period 2005-2008 will be 13% (11% for Romania). This is above the compound yearly average growth rate expected for the new EU member countries like Poland (10%), Czech Rep. (7%), Slovakia (9%).

"We expect the banking sector in Russia to achieve the strongest increase in profitability," says Debora Revoltella. She forecasts average growth of 21 per cent in pre-tax profits in Russia from 2005 to 2008. The Turkish banking sector will as well continue to grow dynamically, even despite current volatility in financial markets.

These figures make Russia one of the most attractive banking markets in Central and Eastern Europe. "This underlines the enormous potential available in this country. The Russian banking market is booming. For this reason we will continue to expand in Russia. As a first step we will double the number of our branches to around 50 by the end of this year and above 100 by 2008," says Andrea Moneta.