Austria: Commercial Banking Report Q1 2011

New Basel Rules Could Impede Growth We believe the Austrian banking sector will move to a lower growth path going forward. Enhanced regulation and higher capital requirements, combined with a weaker demand environment across Europe, will significantly curtail the expansion of Austria's banking industry over the medium-to-long term. Although exposure to emerging markets in South East Europe has caused asset quality at Austrian banks to deteriorate, the industry has so far avoided any major problems. While short-term crisis risks have been diffused by implicit support from the European Central Bank, the growth outlook for the industry is fairly weak. In particular, with banks having to unwind risky positions in emerging markets and shore up their balance sheets, fresh lending will likely be curtailed. In addition, we warn that the move towards enhanced regulation over the medium-to-long term could be a significant impediment to bank operations. In particular, rules being drawn up by the Basel Committee will likely demand higher capital ratios, which will limit asset acquisitions and, in particular, loan growth. UniCredit estimates that Austrian banks may need to find EUR19-35bn in fresh capital to comply with the new regulations. Though new rules have been drafted, it is still unclear what the new Tier 1 capital regulations will be. In any case, the increase will likely have a significant impact on medium-term growth. As such, while financial stability could improve markedly as a result of higher quality regulation, the competitiveness of Austrian banks may suffer significantly as a result. Fiscal Consolidation Will Deal Another Blow Aside from new capital rules and endemic deleveraging, we believe that efforts by governments across Europe to consolidate public finances will be detrimental to the asset growth of Austrian banks. By sapping domestic demand and weakening broader economic activity, fiscal consolidation will dampen asset returns over the medium term. In addition, there is a risk that should governments tighten too much and too soon, the regional recovery could be derailed, putting even greater stress on the Austrian banking sector. As a result of these dynamics, we expect industry growth to move to a lower growth path. We forecast asset growth to average 4.8% over 2010-2014, compared to the 12.1% average for 2004-2008. On the back of rising deposits and more prudent lending, we also forecast a marginal improvement in the loan-todeposit ratio to 122% in 2014, down from 126% in 2010. The risks to our outlook remain weighted to the downside, with an increase in non-performing loans in key south-eastern European markets, as well as the potential for further eurozone sovereign debt ructions, being particularly key threats.