Eastern European banking - McKinsey & Company

Banking and Securities (Europe)
Eastern European banking:
Time to shift gears
Release date: February 2013
Foreword to the Polish edition by:
Jakub Fast and Dawid Rychlik
December 2012
Authors:
Krisztina Bákor
Krisztina Bákor
Miklós Dietz Dietz
Attila Kincses
Irene Shvakman

Foreword to the Polish edition
We are excited to present the 2013 edition of our Eastern
European Banking report.
The Polish banking sector has continued its high performance
through 2011. Polish banks achieved an aggregate
Return on Equity of 13%, as compared to an Eastern
European average of 10%, and zero percent in Western
Europe, and 8% globally. In addition, Poland has further
strengthened its advantage within Eastern Europe, outperforming
countries such as Hungary, Ukraine, Romania and
Bulgaria, with ROEs ranging from -10 to 6%. At the same
time, over a third of the institutions in Poland traded below
their book value in 2011, and failed to produce returns above
their cost of capital.
Three strategic directions best address the current situation
of the banks in Eastern Europe and in Poland in our view:
Portfolio restructuring: conduct asset-swaps and
buyouts to achieve scale in individual businesses and
continue the integration of prior acquisitions
Revision of governance models: pursue cross-border
skill and scale opportunities by, for example, creating
shared services centers serving banks across the region
Operating model innovation: drive new ideas and
efficiency improvements across the product model, the
frontline and the distribution channels, as well as in the
back-office
Jakub Fast
Associate Principal,
McKinsey&Company Poland
Jakub_Fast@mckinsey.com
Two points within this last theme merit additional mention
in the Polish context.
First, we expect defending mass market retail banking profitability
will be of particular focus for Polish institutions in
2013. With the recent interest rates cut to 4% and a potential
to drop to as low as 3.5%, as well as the regulatory limitation
of interchange fees, retail banking revenues will continue
to suffer. If other markets can serve as a guidepost, banks
will focus on deepening profitable segments (e.g., affluent,
small business), drive growth in non-deposit products, and
re-invent the mass-market operating model by leaning out
branches and back-office operations, and developing new,
lower-cost service models for the retail customer.
Second, over a longer term, banks in Poland will need to
actively pursue growth opportunities to defend their market
position. The size of the banking sector in Eastern Europe
is the lowest in the world – at 2.7% of revenue after risk
over GDP, compared to 3.8% for Middle East and Africa or
4.3% for Western Europe. Poland, with 3.7% as of 2011, is
still below global benchmarks. While this spells a favorable
growth trajectory, banks that expect to capture a disproportionate
share of that growth will have to actively pursue
expansion opportunities. Given a relatively low level of
banking penetration in Poland a portion of this growth
is going to come from the currently under-banked massmarket
customer, and given the profitability challenges discussed
above, growing rapidly will require a high degree of
innovation on how to serve that segment of customers in
a profitable way.
Dawid Rychlik,
Associate Principal,
McKinsey&Company Poland
Dawid_Rychlik@mckinsey.com

Contents
Eastern European banking: Time to shift gears
Introduction and summary 1
Eastern European banking: 2011 status and outlook 1
Strong growth is expected to continue following solid progress in 2011 1
Buffeted by structural volatility 2
A year of contrasts: Performance continues to diverge in 2011 and 2012 3
Rapid technological and behavioral changes compound the challenges 4
Accelerated transformation is now imperative 5
Portfolio restructuring and improving the regional governance model: Less progress 5
Innovation: More important than ever 6
Spotlight on the largest markets 10
Bulgaria: Low base rates have reduced margins 10
Czech Republic: The benefits of low loan-to-deposit ratios 10
Hungary: Ongoing regulatory uncertainty 10
Poland: An island of stability, but not without risks 11
Romania: Continued lending growth even after the bubble 12
Russia: Growing state-owned giants 12
Slovakia: Getting a handle on risk and costs 13
Ukraine: Still recovering from the binge 13

Eastern European banking:
Time to shift gears
Introduction and summary
Last year in “Eastern European banking: Moving toward a
new paradigm” 1 we focused on three main themes. First, we
reviewed the “performance paradox” of the last decade, which
saw limited value creation among the group of leading banks
despite a golden era of growth and market-level profitability.
Second, we looked at the macroeconomic trends that are likely
to shape the economics of banking in the region in the next
decade, including fundamental drivers such as low savings
rates and demographic decline, and segment-specific trends
such as urban, trade, and infrastructure development. Third,
we suggested to banking groups that to benefit from these
trends, they should reinvent their business models using four
key levers: portfolio restructuring, changing governance
models, developing differentiated approaches to priority
segments, and innovating in their operating models.
This year’s report examines market developments in 2011
and, where data exist, so far in 2012, and provides our
updated outlook for the Eastern European banking sector. We
discuss how the market has seen a quick rebound in revenues
but has experienced volatility and divergence in performance.
We also make an assessment of the region’s banking business
models, showing that improvements undertaken so far have
taken the sector in the right direction but are not deep enough
to meet its challenges. We argue that it is time for banking
groups to accelerate their transformation efforts and, where
necessary, consolidate their subscale operations. As in last
year’s report, we conclude with a review of the largest banking
sectors in the region.
Eastern European banking: 2011
status and outlook
In 2011, the Eastern European banking sector’s rebound
continued, mainly driven by recovering volumes (up 14 percent
from 2010 to 2011 2 ) and the turn in the risk-cost cycle after the
2009 peak (15 percent decline in 2011 from 2010). Although
there was some margin deterioration (a 13 basis points (bps)
decline in 2011), revenues on a post-risk-cost basis grew 20
percent. This momentum has continued in 2012, though at a
somewhat slower rate. Preliminary figures suggest that volume
growth for the year will be around 8 percent. With stable
margins and continuing risk-cost recovery, growth in revenues
on a post-risk-cost basis for 2012 could reach 12 to 15 percent.
Two factors continue to shape the story of the Eastern
European banking market. First, Eastern Europe has
immense scope to catch up from being the poorest region
in the world in terms of financial wealth relative to nominal
GDP—below even Africa. Second, its population is aging at a
rate similar to that of Western Europe. These two dynamics
are fundamental to the banking sector’s performance and
will continue to drive results going forward. On one hand,
extremely low financial penetration levels all but ensure
brisk revenue growth. On the other hand, the low penetration
levels and unfavorable demographic trends make the region
dependent on external capital, resulting in extreme market
volatility. Market capitalization of the sector still remains
well below its 2007 peak, and the region has the highest
percentage of banks worldwide with a price-to-book value
(P/BV) below one. Under such circumstances, it is no wonder
that a high degree of performance diversity persists among
market participants. Consequently, Eastern Europe is a
region where strategy truly matters.
Below we examine in detail the sector’s growth, volatility,
and divergent performance. We also discuss how changes in
technology and consumer behavior are affecting the sector.
Strong growth is expected to continue
following solid progress in 2011
Revenue after risk cost grew solidly in 2011 (20 percent),
continuing the rebound of 2010 (10 percent). The region
quickly recovered after the trough of the financial crisis,
and outgrew other regions in revenue after risk cost from
2009 to 2011, with a compound annual growth rate of 15
percent, compared with the world average of 7 percent
(Exhibit 1).
The fundamental drivers of the above par growth have been
Eastern Europe’s high real GDP growth (3.0 percent per
annum versus 1.7 percent per annum in Western Europe
between 2009 and 2011) in combination with the gap in the
region’s level of banking penetration compared with other
regions (as shown in Exhibit 1). The region presents very low
retail-banking volumes relative to disposable income (100
percent compared with the 373 percent world average) and
1 The report “Eastern European banking: Moving toward a new paradigm” is available at the McKinsey Global Banking Pools website:
solutions.mckinsey.com/globalbankingpools. For a condensed version of the report, see Miklós Dietz, Adam Homonnay, and Irene Shvakman,
“What’s ahead for banking in Eastern Europe,” February 2012, mckinseyquarterly.com.
2 Regional growth rates are quoted in fixed foreign-exchange-rate terms.

2
Exhibit 1 The growth of the Eastern European banking sector is driven by low penetration. 2011 ESTIMATES
The region’s rebound was strong after 2009… …however, the gap in penetration is still high.
Revenues after risk cost, 2009–11 CAGR 1
$ billion, 2011 fixed FX 2 rate, %
China 37.0%
Eastern Europe 14.8%
MEA 3 12.0%
Latin America 11.0%
North America 9.5%
Rest of Asia 9.4%
Western Europe –1.3%
Japan –6.6%
1 Compound annual growth rate.
2 Foreign exchange.
3 Middle East and Africa.
Source: McKinsey Global Banking Pools
World: 7%
corporate volumes to GDP (56 percent versus the 99 percent
world average). In addition to these low penetration levels,
risk costs are expected to move down from current high
levels, which may provide further support for growth.
Profitability in the Eastern European banking sector also
continued its recovery from its low point in 2009. Return
on equity (ROE) improved across the region: in 2011 the
average ROE in Eastern European banking was 10.0
percent, compared with 2010’s 7.5 percent.
Based on the strong fundamentals, Eastern Europe is
likely to stay one of the fastest-growing banking regions in
the world. Preliminary 2012 results support this positive
outlook. The further growth in banking revenue will be
mainly fueled by volume expansion (especially by personal-
finance asset growth), partially offset by tighter margins.
Buffeted by structural volatility
The region’s dependence on external capital means that
volatility will remain a structural feature of the region’s
economy. Thus, weaknesses in Southern Europe or elsewhere
have negative consequences for the region. During 2011,
average credit-default-swap spreads of Eastern European
Revenues after risk cost/GDP, 2011
%
3 Average of Bulgaria, Czech Republic, Hungary, Poland, Romania, Russia, and Slovakia.
China 7.4%
Latin America 7.1%
North America
Japan
Western Europe
Rest of Asia
MEA 3
Eastern Europe 2.7%
4.4%
4.3%
4.3%
3.8%
World: 5.1%
6.3%
countries 3 increased by around 170bps (up to approximately
270 bps in certain countries). While spreads have shrunk
during 2012, they clearly have the potential to open up again.
A slowdown in Eastern Europe as a reaction to South European
developments is already visible. Macroeconomists have
adjusted growth forecasts for the region: the expected average
nominal GDP growth for the next three years has decreased by
about 1.1 percent per annum.
Market capitalization and price-to-book valuations provide
further evidence of the sector’s extreme volatility. The market
capitalization of the banking industry in Eastern Europe has
endured the most pronounced swings of any region worldwide.
The industry’s market capitalization recovered quickly
following the collapse in 2008, when it fell 75 percent within
a year. After a rapid rebound of approximately 250 percent
during 2010, market capitalization fell abruptly once again,
down by around 30 percent through the end of 2011. Market
capitalization increased only modestly during 2012, reaching
$170 billion in November (Exhibit 2).
As a result of cautiousness in capital markets, the Eastern
European banking sector experienced the largest fall in

Banking and Securities (Europe)
Eastern European banking: Time to shift gears 3
Exhibit 2 The roller coaster continues in banking-asset valuation.
Market capitalization of top Eastern European banks 1
2000 = 100
2,600
2,400
2,200
2,000
1,800
1,600
1,400
1,200
1,000
800
600
400
200
Top:
fastest-growing region
(total growth of ~20x)
0
2000
Bottom:
largest collapse
(decline of ~70%)
Top:
fastest recovery
(growth of ~2.5x)
P/BV ratios of any region, and as of November 2012 the
region has the highest percentage worldwide of banks with a
P/BV below the value of one—74 percent versus a 61 percent
world average. This means that three out of four Eastern
European banks will not be able to earn an ROE higher than
their cost of capital, posing a huge question mark about the
sustainability of their business models despite the growth
potential of the region.
A prolonged bailout of troubled EU countries is negatively
affecting the region, and a eurozone breakup could hit the
region particularly hard. It would not only reduce trade
significantly but would also seriously hurt funding sources
for banks. According to our simulation, a eurozone breakup
would cause three to four years of lost revenue growth for
the region’s banking sector.
A year of contrasts: Performance continues to
diverge in 2011 and 2012
Last year we expressed a view that performance of the
banking sectors in countries across Eastern Europe
would diverge. We clustered Eastern European countries
2007
2008
Bottom:
second-largest collapse again
(decline of ~30%)
2010
1 Sample of 10 listed Eastern European banks with exhaustive market-cap data between 2000 and 2012, plus VTB Bank (Russia)
and PKO Bank Polski (Poland) from 2007.
Source: Thomson Reuters; McKinsey analysis
4 Defined as a combination of loan-to-deposit and Tier 1 capital ratios.
2011
2012
Nov
ESTIMATES
What’s next?
and their banks into groups based on macroeconomic
conditions and banking-sector vulnerability. This
performance differential among the groups has been borne
out, with a growing divergence in performance between
the “performing” and “constrained” markets, as seen in a
widening gap in ROE (Exhibit 3).
The average ROE of the top-performing countries (Russia,
Poland, Czech Republic, and Slovakia—ranging from 11
percent to 15 percent in 2011) was significantly higher than
the average ROE for the constrained markets (Bulgaria,
Hungary, Romania, and Ukraine—with ROEs ranging from
–5 percent to 6 percent). In addition, while ROE results of
the first group improved significantly, performance of the
latter group stagnated, resulting in a widening gap. It is
important to underline that this divergence is occurring due
to accelerating growth of the best-performing countries,
rather than due to deterioration in the performance of the
constrained markets.
As far as financial health, 4 however, the picture is mixed. The
constrained markets are struggling to deleverage and reduce
their loan-to-deposit ratios to healthy (approximately 100

4
Exhibit 3 An increase in diversity is reflected by the widening return-on-equity gap
between the ‘performing’ and ‘constrained’ markets.
Market return on equity (ROE)
%
18
16
14
12
10
8
6
4
2
0
–2
–4
2007
2008
Source: Annual reports, McKinsey analysis
2009
2010
percent) ranges, revealing continued funding difficulties.
However, these markets actually overtook the performing
markets in terms of Tier 1 ratios, driven by needed capital
injections, but the bolstering of capital reserves undertaken
by the constrained-market banks may have contributed to
their poorer performance during this period.
The increasing divergence of performance is not just at
the country level. Indeed, there are large value-creation
differences among the largest banking players in the region.
“Performing”
“Constrained”
Rapid technological and behavioral changes
compound the challenges
The banking executives we surveyed agree about the
importance of technological adaptation as the most influential
factor shaping the future (Exhibit 4). Recent technological
changes, however, present a potential threat to the Eastern
European banking sector’s economic pillars of high margins
and low cost, features that have been built up in a market
that has a different structure and consumer profile from
that of Western Europe. A comparison between Poland’s
and the United Kingdom’s retail markets is illuminating.
While penetration of financial services is similar, the average
financial asset base held by individuals in Poland is only 1/12
that of the United Kingdom. Like other Eastern European
banking sectors, Polish banks compensate for lower-average
2011
Market ROE
%
25
20
15
10
5
0
2007
08
Market ROE
%
20
15
10
5
0
–5
–30
2007
08
09
09
10
10
Russia
Poland
Slovakia
client volumes through lower operating costs (Poland’s
costs are one-third those of the United Kingdom) and high
margins (three to four times higher in Poland than the United
Kingdom). Consequently, Poland’s banks earn a retail ROE
above the level of UK banks.
Why might technology pose a threat to Eastern European
banks? Because the market’s high margins attract all sorts of
new entrants—including technology-enabled online and direct
attackers as well as nonbanking players. These new entrants
are gradually pushing down margins. At the same time the
region’s cost advantage is eroding rapidly due to the global
pricing of many elements, such as IT systems, as well as rising
wages.
Changes in customer behavior also drive technological
advances. Increasing numbers of customers demand online
solutions—a 20 percent decline in branch visits is expected
over the next five years in the region along with increasing
automation to align with customer desires (which could result
in a 10 percent decline in branch staff numbers over the same
period). In addition, Eastern European youth are catching
up to their Western European peers in Internet usage (above
95 percent in the 16-to-24 age group in certain countries,
such as Poland). Banks must adjust their service offerings to
accommodate these new needs.
11
2011
ESTIMATES
Czech Rep.
Bulgaria
Romania
Ukraine
Hungary

Banking and Securities (Europe)
Eastern European banking: Time to shift gears 5
Exhibit 4 According to strategy executives, technology will shape the future of Eastern European banking;
innovation is essential to create value.
Top results
%
“What will be the 3 main forces shaping the
future of the banking sector in Eastern Europe?”
Technological change,
eg, mobile payments
Changes in regulations 67
Macroeconomic conditions
Performance of parent banks in
their home markets
Source: Clients surveyed (overall responses: 18)
Accelerated transformation is
now imperative
We believe that there are three priority initiatives for
Eastern European banks to pursue to boost performance
in the coming years: portfolio restructuring, improving
the regional governance model, and making headway on
operating-model innovation, including the development
of differentiated approaches to capture the most attractive
customer segments. Progress to date with these initiatives
has been slow, however, and we believe bolder efforts are
needed in the years to come (Exhibit 5).
Portfolio restructuring and improving the
regional governance model: Less progress
In last year’s report we argued that the regional-banking
landscape was shaped by a history of many subscale and
opportunistic acquisitions. As a result, banking groups
now need to focus on asset swaps and buyouts to achieve
critical scale in each market. Despite the fact that further
consolidation is needed, progress is slow as groups are
reluctant to write down assets or pursue acquisitions in
today’s capital-constrained environment. But failing
to address subscale businesses is likely to be costly: our
experience suggests that subscale subsidiaries suffer most in
downturns due to their weaker margins.
33
50
83
“What will be the 3 most important levers for
creating value in the next 10 years in the region?”
Product and channel innovation
Strategic focus on specific
products/services
Reducing costs 50
Growth of intragroup cross-border
operating models
Since our last review, a number of M&A deals have taken place
in the region, notably in Russia and Poland. Nonetheless,
the lineup of the top ten regional banks by assets has barely
changed. Gazprombank is the only new entrant to this group,
while VTB gained the most in market share, now ranking
second behind Sberbank. Although current low valuations
create an unfavorable situation for M&A, there are signs of
further exits and consolidation, for example, Bayerische
Landesbank’s plan to sell MKB in Hungary. In our view, there
is much more portfolio restructuring waiting in the wings.
We also continue to believe that Eastern European banks
should revise their regional governance models to more
forcefully pursue cross-border skill and scale opportunities.
To date we have seen only limited progress to realize this
potential. To move forward, Eastern European banks
should look outside the region to help them create a
clear vision for their operating models. They should look
closely at how some banks in Scandinavia have optimized
operations across that regional market, which offers
parallels to relatively small, adjacent country markets.
Emerging-market banks also provide examples: Ecobank,
for instance, recently implemented a pan-African approach
to standardized operations across 33 countries. We firmly
believe that regional governance models should not only
pursue the sharing of best practices but should also drive
the standardization of formats and processes and drive the
collocation of shared services in low-cost centers.
33
50
67

6
Exhibit 5 There are three key strategic initiatives.
Progress in
2011–12
Description
Examples
Portfolio
restructuring
▪ Concentrating on priority
markets, eg, by asset swaps,
acquisitions, or market exit
from subscale businesses
▪ Only a few market players
made acquisitions or exited
Eastern European countries
Innovation: More important than ever
Banks must increasingly cope with other challenges, including
growing expectations and shifting behavior patterns of
consumers as well as intensifying competition, including
from nonbank entrants. For example, new payments solutions
introduced by telecom companies and online players are
threatening payments-related revenues streams. Aggregator
and ranking Web sites such as Mint are increasingly becoming
the go-to source for customers searching for financial
products and have the power to redirect clients. Taken to their
extreme, these trends have the potential to change the overall
distribution model for financial services and to further dilute
the banks’ hold on customers.
The threat of nonbanking attackers is particularly high in
Eastern Europe. High margins make the market attractive,
while the banks are relatively young compared with their
Western European peers and so have less extensive and
elaborate infrastructure. Consequently, new technology
creates opportunities for “leapfrogging.” In addition, given
lower customer value, players must design lower-cost
distribution and service models as well as basic product
offerings, designed to meet the preferences of local consumers.
With new competitors and technologies increasingly sweeping
the market, in addition to the growing sophistication of
consumers, erosion of profit margins is in the cards. Banks
will need to find breakthroughs to lower their costs. We have
seen some efforts in the past several years to reduce branch
Evolving the regional
governance model
▪ Building stronger regional
governance model to achieve
skill and scale economies
▪ No major examples occurred to
copy successful models, eg, in
Scandinavia or other emerging
markets; some discussion
started on joint utilities
Innovating operating
models
Slow Fast Slow Fast Slow Fast
▪ Providing innovative services
and products to target
segments using novel
distribution techniques and
low-cost back-office solutions
▪ Some new payment
solutions, novel branch
formats, and leantransformation
programs
have been started
infrastructure and personnel—the number of branches in the
region (excluding Russia) has started to fall (down 2.7 percent
from 2009 to 2011). However, these have not been enough to
offset the rising operating costs and, consequently, overall
banking-industry operating costs have increased, rising 22
percent in 2011 (Exhibit 6).
To tackle these challenges, the banking executives we surveyed
said they believe the greatest focus should be on product and
channel innovation (Exhibit 4). Some innovative banking
solutions are already emerging in response (Exhibit 7).
— Product and service innovation: Several banks
have introduced new payment solutions, such as peerto-peer
services, as well as comprehensive digital
payment platforms accessible from smartphones,
with wide functionality that ranges from buying movie
tickets to settling traffic fines.
— Frontline and distribution innovation: A
number of banks are bringing smart solutions to
their branch networks, including closing traditional
offices in favor of specialized minibranches in
hypermarkets and integrating with retail stores.
They are also using advanced technologies that
reduce the need for face-to-face interaction, such as
the use of biometric identification.
— Back-office innovation: A number of banks have
started to deploy lean-transformation approaches,

Banking and Securities (Europe)
Eastern European banking: Time to shift gears 7
Exhibit 6 Cost-effectiveness varies, highlighting a need for many banks to improve.
Absolute costs
2007 = 100%
135%
130%
125%
120%
115%
110%
105%
100%
Cost/income ratio
%
48%
46%
44%
2007
0%
2007
46
08
08
%
09
42%
09
2010
47%
2010
+22%
2011
50%
2011
Distribution of cost/income ratio, 1 % of banks
15%

8
including in branch formats and layouts, flexible
workstations, organizational structures, and
processes, as well as continuous-improvement
initiatives. In addition to cutting costs, lean
transformation improves service levels and increases
customer satisfaction.
— Success stories: In Poland, Alior Sync has pioneered
frontline and service innovation with the development
of social-media-embedded online-banking solutions,
including Facebook links, video-chat functionality,
a wide media offering, and other services. Russia’s
Sberbank has also made progress in a number of these
areas, launching text-message-based peer-to-peer
payment services along with “truth verifying” ATMs
that grant loans using polygraphs and developing lean
solutions that are continuously updated with new
ideas drawn from its staff. Meanwhile, Raiffeisen has
undertaken a number of successful initiatives in lean
transformation, including maximizing workstation
flexibility and near-shoring of back-office units to
lower-cost rural locations.
While innovative solutions are emerging across the region,
Eastern European banks can also learn from new innovative
solutions introduced by banks in other emerging markets.
— Product and service innovation:
□ Several Asian banks have introduced futuristic
branch layouts with interactive touch screens,
opportunities to video chat with experts at other
locations, and customized packages specifically
targeted at the technology-savvy generation.
□ Frugal innovation approaches also offer great
potential. Several financial and nonfinancial firms
have been very successful with such approaches in
India and Africa (for example, Safaricom’s M-Pesa
payment solution).
— Frontline and distribution innovation:
African and Latin American banks have developed
effective approaches for reaching less populated
areas with “traveling bank” solutions, for example,
ATMs on buses and boats or other types of traveling
minibranches.
— Back-office innovation:
□ Design-to-cost approaches can be applied
to rethink operating models and end-to-end
processes. Banks that have applied such
approaches in mortgage-processing redesign, for
example, have achieved savings of 20 to 40 percent.
□ Banks can also think about the next level of
outsourcing, using multibank service centers
that are able to offer standard IT and operations
solutions more cheaply to multiple banks.
In conclusion, the banking sector in Eastern Europe holds
much promise for growth but continues to be challenging
(Exhibit 8). While a number of markets, such as Poland and
Russia, are poised to outperform in the short to medium term,
and other countries might also start the rebound, the sector
as a whole is facing headwinds due to its reliance on external
capital and to growing pressure on margins. While some
regional players have started to embark on transformation, it
is still too early to judge if these efforts go far enough to make
a difference to the fundamentals. In the coming years, we
hope to see bolder and more structural change taking hold.
Further portfolio restructuring and evolution in regional
governance will be needed to achieve scale. Innovation in
operating models, formats, and channels is likely to be the key
to unlocking the sector’s full potential and to counteracting the
risk from new competitors. It is time for banks to shift gears
and embrace transformation. Those that do so can expect to
capture substantial rewards.

Banking and Securities (Europe)
Eastern European banking: Time to shift gears 9
Exhibit 8 Key performance indicators of the Eastern European banking markets
indicate growth potential, but also challenges.
Revenue
growth1 Loan-todeposit
Lending/
ROE ratio GDP2 Tier 1
capital
ratio NPL3 %, local-currency terms
Bulgaria 2007 24% 18.4% 117% 73% 10.8% 2.1%
Czech
Rep.
Hungary
Poland
Romania
Russia
Slovakia
2010
2011
2007
2010
2011
2007
2010
2011
2007
2010
2011
2007
2010
2011
2007
2010
2011
2007
2010
2011
Ukraine 2007
2010
2011
18%
5%
12%
–2%
4%
5%
20%
–16%
18%
19%
18%
24%
18%
11%
25%
8%
21%
19%
–9%
6%
70%
n/a 4
n/a 4
6.1%
5.6%
17.6%
16.0%
15.2%
16.1%
1.2%
–9.7%
19.2%
10.0%
13.1%
6.6%
–2.2%
–1.1%
14.7%
9.5%
13.5%
14.2%
8.6%
11.2%
8.8%
–8.3%
–4.6%
129%
117%
ESTIMATES
1 Revenue after risk versus previous year.
2 Total retail and wholesale (including nonbank financial institutions and public) lending volumes to nominal GDP.
3 Nonperforming loans.
4 Not applicable due to negative revenues (–$2.2 billion in 2009, –$0.3 billion in 2010, $3.5 billion in 2011).
Source: World Bank; annual reports; McKinsey Global Banking Pools
90%
85%
82%
148%
149%
137%
104%
117%
122%
120%
137%
141%
113%
95%
101%
120%
106%
114%
151%
176%
160%
80%
75%
56%
61%
60%
71%
80%
76%
43%
58%
62%
44%
56%
55%
42%
45%
49%
49%
57%
59%
63%
71%
64%
15.2%
15.6%
10.4%
13.9%
14.2%
8.8%
11.3%
11.0%
10.5%
12.4%
11.7%
8.8%
11.3%
11.0%
15.5%
18.1%
15.1%
11.2%
11.5%
11.7%
13.9%
20.8%
18.5%
11.9%
13.5%
2.7%
6.2%
5.6%
2.3%
9.7%
10.4%
5.2%
8.8%
8.4%
2.6%
11.9%
13.4%
2.5%
8.2%
8.0%
2.5%
5.8%
5.8%
3.0%
15.3%
15.4%

10
Spotlight on the largest markets
Bulgaria: Low base rates have reduced
margins
Banking growth and profitability trends
— The Bulgarian banking sector has seen another year
of decline in profitability (in terms of ROE); 2011
was the fifth consecutive year for such a decline.
The sector operated with a 5.6 percent ROE in 2011,
significantly below the Eastern European region’s cost
of equity, which is in the 14 to 16 percent range. Despite
achieving a relatively strong compound annual
growth rate of 9 percent in customer volumes between
2007 and 2011, revenues declined at a compounded
annual rate of 2 percent over the same period. The
main reasons for the weak performance are lower
money-market rates and, as a result, declining deposit
margins. Interest and fee margins declined by 109 bps
between 2007 and 2011, while risk costs remained at
a high level. The sector’s nonperforming loan (NPL)
ratio reached 13.5 percent, the highest level since
the beginning of the crisis. However, the banking
sector became more stable in 2011: there was strong
deleveraging, and loan-to-deposit ratios declined by 12
percentage points because retail deposits increased 13
percent while lending saw no growth.
Competitive trends
— Foreign interest in the market has increased in
recent years, with players from Eastern Europe and
neighboring countries such as Turkey being more
active than Western European ones.
— Fragmentation appears to be increasing: the market
share of the top five banks has declined from 57
percent in 2007 to 52 percent in 2011.
Challenges and opportunities
— As revenues from core lending activities will be
growing more slowly, banks will have to start relying
on other, less traditional business segments to build
their revenues, for example, encouraging development
of a more sophisticated savings culture.
— A package of legislative amendments on bank fees and
loan interest rates is under discussion, which could
have an impact on bank revenues.
Czech Republic: The benefits of low loan-todeposit
ratios
Banking growth and profitability trends
— The Czech banking sector has been one of the most
resilient in Eastern Europe through the crisis. Average
ROE has remained at a high level—at 15.2 percent in
2011—and has exhibited a remarkable level of stability
compared with other countries in the region. While
total deposits increased by 5 percent in 2011, the
momentum of lending growth has almost halted, with
total lending volumes growing by only 1 percent from
2010 to 2011, reflecting a 3 percent expansion in retail
lending but a 1 percent decline in corporate lending.
There was no significant change in revenue margins,
but thanks to decreasing risk costs, revenues after risk
cost increased by 4 percent, a faster pace than GDP
growth. The NPL ratio also improved in 2011, falling
by 0.6 percentage points to 5.6 percent.
Competitive trends
— Three small banks with innovative value propositions
entered the market in 2011, an indication of the
attractiveness of the Czech market.
Challenges and opportunities
— Some upcoming regulatory changes are likely to affect
the market. The opening of the second pension pillar
beginning in 2013 will give banks the opportunity
to participate in a market that is estimated could be
worth approximately €2 billion by 2015.
— Changes in building society regulations are expected
to open the market to all banks rather than only
specialized players after 2015.
Hungary: Ongoing regulatory uncertainty
Banking growth and profitability trends
— The sector suffered significant losses in 2011, with its
ROE falling to –9.7 percent. Hungary’s weak economic
performance compared with other Eastern European
countries is just one factor contributing to declining
profitability. Regulatory uncertainties persisted in
the sector in 2011. Business volumes declined due to

Banking and Securities (Europe)
Eastern European banking: Time to shift gears 11
the nationalization of private pension funds, while
risk costs rose, mainly due to further deterioration in
the asset quality of foreign exchange (FX) loans and
mandatory early repayment rules. The NPL ratio of
the sector climbed to a record high of 10.4 percent in
2011. In 2012, new lending volumes have declined and
NPLs have increased further, driven by the worsening
situation in the corporate sector. The combined effect
of declining business volumes and after-risk margins
led to a significant drop in after-risk revenues.
Many banks have tried to reduce their operating
costs by restructuring operations, including closing
branches—60 branches were closed in 2011 and a
further 90 in the first half of 2012.
Competitive trends
— While several players are looking to decrease their
exposure to the Hungarian market, major M&A
activity is unlikely due to regulatory uncertainties,
unless the state itself acts as a buyer.
— To meet their funding needs in 2011, many banks
continued to compete for retail deposits by offering
rates above the interbank lending rate (typically
offering such rates on 3- to 12-month deposits of new
savings). Competition for deposits has started to ease
during 2012.
— Most players are offering consumer finance only to
existing customers and focusing primarily on current
account offers.
— Offerings of high-yield mid- and long-term
government bonds are creating competition for funds
and putting further competitive pressure on bank
deposit volumes. These offerings have been supported
by a strong marketing campaign; the total volume of
these instruments increased 17 percent between the
end of 2011 and mid-2012.
Challenges and opportunities
— The sector continues to face uncertainties related to
regulations going into 2013. For example, bankingtransaction
revenues will be hit by the newly
introduced “transaction tax.”
— The large-scale program under way to fix the rate of
FX-denominated loans will likely halt the growth
of retail NPLs and may slowly improve retail-asset
portfolios. However, low housing prices will likely
postpone any recovery.
Poland: An island of stability, but not without risks
Banking growth and profitability trends
— In common with its overall economy, Poland’s banking
sector has remained relatively stable through the
crisis. Although ROE has not yet returned to pre-crisis
levels, the fall in profitability was less severe than
in other countries in the region. Revenue growth in
2011 was driven by decreasing credit risk (risk costs
declined by 3 percentage points from 2010 to 2011) and
strong volume expansion (11 percent), in particular on
the lending side. Cost efficiency increased, reflected
in the fall in the sector’s cost-income ratio from 53
percent to 51 percent. Although the Polish banking
sector is one of the most stable in the region, its
loan-to-deposit ratio (122 percent) is well above 100
percent, and it continues to rely on external funding
sources. A possible downturn could hit Poland
especially hard due to its banks being far less prepared
than their crisis-scarred peers in other countries.
Competitive trends
— Poland is one of the most attractive markets in the
region when it comes to M&A activity. There were
significant acquisitions during 2011, and more are
anticipated.
— Banks are reinventing their distribution strategies.
Moves include setting up virtual branches, downsizing
branch networks except in large cities, and developing
a wide reach in rural and urban Poland using
minibranches.
— The rare example of an initial public offering by a small
innovative bank—Alior—indicates continued trust on
the part of stakeholders.
Challenges and opportunities
— Regulatory changes related to interchange fees
(which are currently among the highest in the EU)
are expected, as well as changes to bancassurance
(most likely resulting in a reduction in bancassurance
distribution fees).
— The long-discussed reform of the public-pension
system (decreased contributions to the second pillar,
with contribution inflows redirected back to the first
pillar) is expected to spur greater interest in long-term
savings products offered by banks and insurance
companies.

12
Romania: Continued lending growth even
after the bubble
Banking growth and profitability trends
— Romania’s banking sector remains vulnerable due
to the rising share of nonperforming loans and the
high foreign-currency indebtedness of the private
sector. Loan portfolios have continued to deteriorate,
although at a slower pace than a year earlier; the
proportion of NPLs reached 13.4 percent in 2011.
Small and medium-size enterprises (SMEs) were
the worst hit: the NPL ratio for SMEs posted the
fastest growth and is at the highest level. Credit risk
of household loans also rose, with high indebtedness
and FX exposure remaining the key challenges. The
banking sector’s loan-to-deposit ratio is among the
highest in the region (141 percent), a further weakness.
— Volumes posted modest growth during 2011, with
lending and deposit markets both increasing by
approximately 6 percent. This growth was mainly
driven by corporate lending and retail deposits (up 8
percent and 10 percent, respectively). Retail-lending
and corporate-deposit market volumes remained
flat during 2011, with the level of new inflows staying
significantly below pre-crisis levels.
— The banking sector reported an aggregated loss for the
second consecutive year.
Competitive trends
— A number of banks resized their networks and cut
staff: in 2011, 124 branches were closed, and the
number of employees fell by approximately 1,000.
— Foreign-owned banks have started deleveraging;
however, a withdrawal of foreign banks from the
Romanian market remains unlikely.
— The market has seen even negative margins on new
volumes of certain products, as some banks (notably
Greek players) paid deposit interest at levels higher
than interbank rates to cover their loan-to-deposit gap.
— Top players managed to stay profitable in 2011 due
to their scale advantage and large network presence,
which remains a key success factor. However, a large
portion of the smaller banks suffered losses for the
second consecutive year.
Challenges and opportunities
— Maintaining a stable liquidity position might become
a challenge as the Tier 1 ratio is among the lowest in the
region, although still at 11 percent.
— In the next few years, more aggressive cost cutting is
expected, including further branch rationalization.
— Growth of lending and savings is expected to exceed
GDP growth in the midterm, as Romania’s lending and
savings markets are among the least developed in the
region.
— The ability of banks to achieve greater penetration of
Romania’s relatively economically underdeveloped
rural population—approximately 45 percent of the
total—will determine the evolution of the market in the
medium to long term.
Russia: Growing state-owned giants
Banking growth and profitability trends
— The Russian banking market has delivered one
of the quickest rebounds since 2009. ROE levels
returned to pre-crisis levels in 2011, reaching 13.5
percent, well above the Eastern European average
of 10 percent. Growth in 2011 was mainly driven by
strong volume expansion (26 percent) and declining
credit risk. The strong volume growth translated to
only moderate banking revenue growth because of
eroding corporate-banking margins, mainly the result
of intensifying competition. However, performance
is very much dependent on the business mix, as retail
margins remained strong in spite of the product mix
seeing a degree of shift toward savings products with
lower margins.
— Russia is one of the most underpenetrated countries in
the world by financial-savings measurements, which
is expected to result in higher deposit growth rates.
The loan-to-deposit ratio is close to 100 percent in
the sector on average. However, for many private and
international players, the ratio is much higher than
100 percent.
Competitive trends
— The overall strong performance of the Russian
banking sector is to an extent a reflection of the
performance of Sberbank and its strong customer

Banking and Securities (Europe)
Eastern European banking: Time to shift gears 13
base: in 2011 Sberbank accounted for nearly half of
the Russian banking sector’s total profits and over
a quarter of its assets. A number of other banks saw
weaker profitability.
— Competition has intensified: state-owned banks
are increasing market share in all segments, and
banking consolidation is taking place in the public
and private sectors. At the same time, several retailfocused
attackers continue to successfully build a
visible presence in the market using innovative sales
approaches combined with aggressive marketing and
pricing.
— Ongoing liquidity pressure keeps funding costs high,
while competition and regulation are squeezing banks’
margins.
— Many nonbanking players are entering the space with
some initial success, for example, Svyaznoy.
Challenges and opportunities
— Large state-owned banks with low funding costs,
healthy capital ratios due to easy access to capital,
large regional networks, and the ability to cherry-pick
corporate customers enjoy a significant competitive
advantage. To be able to stay competitive in their
squeezed position, other players in the market should
focus on excellence in operations, risk management,
and sales and marketing.
— While top banks have a stable capital position (15
percent Tier 1 capital ratio on average in 2011), high
lending growth rates along with the upcoming
transition to Basel III pose pressure on capital
adequacy. These pressures may force some banks to
slow down the pace of lending growth or, alternatively,
look for additional capital injections or to sell some
assets.
— Consumer preferences are shifting toward more
complex products, for example, mortgages.
Development of the mortgage market is also being
supported by state bodies.
Slovakia: Getting a handle on risk and costs
Banking growth and profitability trends
— Slovakia’s banking sector has remained strong due
to its embrace of conservative business models, high
Tier 1 ratios, and low levels of corporate and private
indebtedness. The banking sector achieved a healthy
level of ROE in 2011: 11.2 percent. Business volumes
increased by 6 percent, mainly driven by retail-lending
expansion, up 11 percent. Although retail risk costs
slightly increased, there was a big improvement in
corporate credit quality, which led to a better overall
risk-cost situation. These positive trends, combined
with operational-efficiency improvements, helped the
sector to improve profitability significantly from 2010
to 2011. However, due to credit expansion, the sector’s
loan-to-deposit ratio has increased by 8 percentage
points, and is now well above 100 percent.
Competitive trends
— The sector remains quite fragmented for a relatively
small market, with no substantial M&A activity.
Challenges and opportunities
— Additional banking taxation poses the biggest threat
to profitability. The new levy will at a minimum reduce
ROE by about 1.0 to 1.5 percentage points.
— If overall unemployment worsens and economic
growth slows, it could result in lower demand from
clients.
Ukraine: Still recovering from the binge
Banking growth and profitability trends
— Despite a 13 percent expansion in business volumes
in 2011, the Ukrainian banking sector has still not
been able to recover fully from the damage caused
by the global financial crisis. Profitability has
rebounded from its trough in 2009, but the sector
as a whole remained in the red in 2011. Three key
factors contributed to this weak performance in 2011.
First, the loan-to-deposit ratio remained high at 160
percent (even though that represents a substantial
deleveraging from 2010’s 176 percent). Second, the
sector’s NPL ratio increased further to 15.4 percent –
the highest level in the region. Third, banks’ operating
costs increased by close to 30 percent, putting
additional pressure on profitability.
Competitive trends
— The Ukrainian banking sector remains fragmented,
with the top five banks controlling less than 40 percent
of the market and more than 150 banks operating in
the country.

14
— The market share of foreign-owned banks was 37
percent in 2011, down significantly from its level
in 2008 and now at a level that is relatively low for
the region. Further exits of West European banks
are expected, but there has been a recent push from
Russian players to increase market share, especially in
the corporate segment.
— Many larger banks have resumed making hryvnadenominated
consumer loans, but overall total retail
lending declined by a few percentage points in 2011.
Challenges and opportunities
— The high level of fragmentation in the banking
sector may present acquisition opportunities, but
international banks remain cautious because of the
unstable macroeconomic environment and regulatory
uncertainty.
— An expected further devaluation of the hryvna against
the dollar is putting pressure on Ukrainian banks,
since a large part of their stock of loans is still in dollars
and so devaluation would lead to increased capital
requirements and potentially result in more NPLs.
— While a few players have restructured or sold their
NPLs portfolio, a very high level of NPLs persist in the
system and this is hampering growth.
— Liquidity is still a major concern for banks. Many
banks have offered significantly higher interest
rates to try to attract deposits – which has hurt their
profitability – while some have slowed their lending
significantly while waiting for the situation to resolve.
Krisztina Bákor and Attila Kincses are consultants in McKinsey’s Budapest office, where Miklós Dietz is a principal. Irene
Shvakman is a director in the Moscow office.
The authors would like to thank Andrei Caramitru, Jakub Fast, Vladimir Kreidl, Georges Massoud, Tomas Visek, Cornelius
Walter, Semyon Yakovlev, and Igor Yasenovets for their contributions to this article, and Valentin Mihov and Tamás Nagy for the
underlying analytical work.
Contacts for distribution:
Miklós Dietz
Phone: 36 (1) 3738520
E-mail: miklos_dietz@mckinsey.com
Attila Kincses
Phone: 36 (1) 3738741
E-mail: attila_kincses@mckinsey.com

Banking and Securities (Europe)
December 2012
Designed by Global Editorial Services design team
Copyright © McKinsey & Company