Banking in SEE: moving into the spotlight Euromoney Conference, Dubrovnik October 16 th Debora Revoltella UniCredit Group CEE Chief Economist

2 EXECUTIVE SUMMARY nA region which continues to deliver strong growth with moderate risk, but with rising disequilibria nStrong banking growth and profitability. The retail segment remains the most dynamic at the regional level, with households financial penetration increasing both on the assets and the liabilities side nBanking sectors are generally well-capitalised and profitable with the widespread presence of foreign players having contributed to the significant improvement in market conditions. Prudential requirements are also strict nAlthough risks on the households’ side are still controlled, possible source of vulnerabilities remain connected to the fast pace of growth in credit - which is leading to widening external disequilibria, households’ exposure to FX risk and increasing financing gap nIntense monitoring and adequate policy responses are crucial to prevent major deviations from an healthy convergence pattern

3 Agenda Persistently strong growth and rapid financial deepening… …but increasing risks!

4 The SEE region continues to deliver strong growth and moderate risk… GDP growth in SEE is well above EU driven by lively consumption and investment activity Significantly improved risk profile: 82% of the Region’s GDP investment grade Real GDP growthRisk profile - S&P rating weighted per GDP (1) Sep 2007 > BBB- 81.7% Sep 2004 > BBB- 36.0% pps Note: SEE: Bulgaria, Romania, Croatia, Bosnia & Herzegovina and Serbia Source: UniCredit Group New Europe Research Network ‘ BBB’ : Croatia, Bulgaria, Romania ‘BB’: Serbia (1) For Sep 2007 S&P ratings, GDP as per end of 2006 For Sep 2004 S&P ratings, GDP as per end of 2003 'BBB' 81.7% 'BB' 18.3% 'BBB' 36.0% 'BB' 64.0%

5 … but shows increasing external unbalances CA deficit and its financing (% of GDP)  Strong consumption and investment lead to strong import demand and thus CA unbalances  This might be a natural phase in the transition process, amid the need of upgrading the country capital stock and households desire to increase living standards  In the short term, FDI inflows can help financing the saving gap  To evaluate sustainability in the long term, it is crucial to understand if the national saving gap is endangering the long term competitiveness of the country Source: UniCredit New Europe Research Network

6 The financial deepening scenario is expected to continue… Note: (1) Total loans/deposits include general gov.t, non-financial corporations, households and when available non-profit institutions serving households (NPISHs) and non-monetary financial institutions (Non-MFIs); SEE: Croatia, Bosnia, Serbia, Romania and Bulgaria; (2) European Monetary Union; (3) as of Source: UniCredit Group New Europe Research Network based on data from local Central Banks. Banking penetrations in 2006 (Loans+Deposits)/ GDP EMU 2 214% SEE Branches per mln inhabitants EMU 2, SEE 82% 1 SEE Dep.’ volumes growth (2000 =100, in € terms) SEE Loans’ volumes growth (2000 =100, in € terms) 16% p.a. 19% p.a. CAGR ‘06-’09 25% p.a. 23% p.a. CAGR ‘06-’09 20% p.a. 19% p.a.

7 …being supportive for still strong banks’ profitability Euro bn SEE PROFIT BEFORE TAX (1,2) Note: (1) SEE: BG, BiH, HR, SRB and RO; (2) Before tax and extraordinary items Source: UniCredit New Europe Research Network CAGR +19% Volumes Spreads Retail vs. corporate mix Fees & Comm. vs. interest income mix Impact on revenues Croatia Bosnia Serbia Romania Bulgaria Lending volumes and revenues growth CAGR revenues mkt growth (’06-’09) CAGR total loans (’06-’09) Weight on SEE revenue pool (’07-’09) ~ 35bn €

8 Agenda Persistently strong growth and rapid financial deepening… …but increasing risks!

9 Is the current pace of lending growth sustainable? Private sector loans penetration potential vs actual (as a percentage of GDP) 1  Data still indicate the persistence of some penetration gap on the lending side, but this is shrinking in SEE  Good macroeconomic performance and further convergence in interest rate levels will be major drivers of future banking growth Notes: (1) CEB: V4 and the Baltics; other: Russia, Turkey and Ukraine. Based on out-of-sample estimation by regressing the level of loans’ penetration on GDP per capita in PPS and real interest rates using Eurozone countries as a benchmark Source: UniCredit New Europe Research Network Potential 2006

10 Are households getting too much indebted? Note: (1) Data for Serbia refer to share of credit to the non-government sector denominated or indexed in FX Source: UniCredit New Europe Research Network Risks on the households side are still controlled… … with rapid credit growth observed in the recent past reflecting, by and large, adjustments from very low initial levels in the context of a relaxation of liquidity constraints Number of evidences show that on aggregate there are no major risks on the horizon… … despite potential sources of vulnerability like the one connected to rising exposure to FX risk Prudent macro policies and strict monitoring of risk remain crucial to prevent deviation from an healthy convergence pattern Household indebtedness (% of GDP) Loans denominated in FX (2006, % of total) 1 n.a.

11 5Y Credit Default Swaps (USD, bps) Reduced liquidity following the recent turbulence on the international markets and increases in credit spreads might determine some gradual credit squeeze in the medium to long term The likelihood and extent of which is likely to be influenced by single countries macroeconomic unbalances and other institutional settings (relevance of foreign ownership in the banking sector) In a generally benign scenario, we see some more risks of a possible credit squeeze for countries with higher external unbalances in the CA or where credit growth is increasingly being financed with banks´external borrowing Source: UniCredit New Europe Research Network, Bloomberg Is there a risk of a credit squeeze? Banks’ financing gap (loans minus deposits, € bn)

12 Top Players in CEE Total Assets (€ bn) UniCredit ERSTE RZB KBC SocGen IntesaSP OTP Contr. to Group’s profits 19% 75% 79% 16% 8% 9% n.s. Share of foreign ownership (% of total assets) The presence of foreign banks with a strong commitment to the region could be a stabiliser effect in SEE… UniCredit ERSTE RZB KBC SocGen IntesaSP OTP Source: UniCredit Group CEE Research (i)100% of total assets, revenues and profit after tax (before min.interests) for controlled Companies (stake > 50%) and share owned for non controlled companies (ii)proforma results include also banks acquired during 2006 and until May 2007

13 … in the context of strenghtened prudential regulation and bank supervision  Throughout the region, credit risk procedures are clearly in place, banking supervision is strong – and has significantly improved in countries like Serbia  Prudential requirements are also strict with most of the countries having implemented credit bureaus and with deposit insurance mechanism already in place  To ensure sufficient capitalization, banks are also required to maintain capital adequacy ratios above Basel requirements  In light of risks associated with fast lending growth and significant ‘euroisation’, several CBs have recently tighten regulatory and prudential norms (like in Bulgaria, Croatia and Serbia) Source: UniCredit New Europe Research Network Capital adequacy ratio (2006)

14 EXECUTIVE SUMMARY nA region which continues to deliver strong growth with moderate risk, but with rising disequilibria nStrong banking growth and profitability. The retail segment remains the most dynamic at the regional level, with households financial penetration increasing both on the assets and the liabilities side nBanking sectors are generally well-capitalised and profitable with the widespread presence of foreign players having contributed to the significant improvement in market conditions. Prudential requirements are also strict nAlthough risks on the households’ side are still controlled, possible source of vulnerabilities remain connected to the fast pace of growth in credit - which is leading to widening external disequilibria, households’ exposure to FX risk and increasing financing gap nIntense monitoring and adequate policy responses are crucial to prevent major deviations from an healthy convergence pattern