The Return of Political Risk: Foreign-Owned Banks in Emerging Europe

Abstract

Political risk—risk that investments are damaged by policy action of authorities—increased during the financial crisis due to controversies about the distribution of accumulated losses among stakeholders. Authorities interconnected by cross-border banks considered unilateral policies that minimised losses for domestic stakeholders at the expense of their foreign counterparts. This is at odds both with the assumption behind financial integration which presumes multilateral responses to cross-border shocks and with the typical definition of political risks that ignores the fact that not only host-country, but also home-country authorities can create such risks. This paper recasts the definition of political risk and reviews instances when political risk materialised within the EU banking market between 2007 and 2011. The analysis reveals that the EU regulatory framework needs to be enhanced to contain resurgent political risks systematically rather than through ad hoc interventions of the EU and international bodies.

Notes

¹ See Bremmer (2006) for discussion of the relationship between political risk and stability.

² Some aspects of political risk are related to Knightian uncertainty rather than risk with known probabilistic distribution, which also hampers attempts to quantify these risks for risk management purposes.

³ See Lu et al., (2009) for a review of the political risk insurance industry.

⁴ See Kudrna (2012) for a related example.

⁵ The VI was concerned with the following 21 countries, which does not necessarily imply that all host authorities participate in every activity: Albania, Belarus, Bosnia & Hercegovina, Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Former Yugoslav Republic of Macedonia, Moldova, Montenegro, Poland, Romania, Russia, Serbia, Slovak Republic, Slovenia, Turkey and Ukraine. The most active host countries are Austria, Italy and Sweden. The participating international financial institutions are the European Bank for Reconstruction and Development (EBRD), the International Monetary Fund (IMF), the World Bank and the European Investment Bank. The EU stakeholders are the European Commission (DG ECFIN), the European Banking Authority and also the European Central Bank (ECB) which participates as an observer. The following banks participated in various activities of the Vienna Initiative: Bayerische Landesbank, Eurobank EFG, Erste Bank, Intesa Sanpaolo, KBC, National Bank of Greece, OTB Bank, Piraeus Bank, Raiffeisen Bank International, Societe Generale, Swedbank and Unicredit. The European Banking Federation also took part.

⁶ International financial institutions also committed €33 billion to emerging Europe, some of which was channelled through transnational banks. However, these were general funds for mitigating the crisis and were not a direct consequence of the VI (EBRD 2012).

⁷ The combined assets of the three largest Austrian banks in the region surpassed Austria's annual GDP.

⁸ Available at: http://www.eib.org/attachments/vienna-2-0-sc_-warsaw-12-july-2012-deleveraging-monitor_letterhead.pdf, accessed 4 August 2012.