Central, Eastern Europe banks hold high at-risk loans amid geopolitical tensions

Banks with significant operations in central and Eastern Europe held the highest portion of loans at increased risk of default as the region grapples with geopolitical risks due to Russia's ongoing war against Ukraine.

Austria-based Raiffeisen Bank International AG (RBI) and Erste Group Bank AG, Poland-based PKO Bank Polski SA and Hungary's OTP Bank Nyrt. had the highest stage 2 loan ratio among their European peers at the end of March, according to S&P Global Market Intelligence data. Stage 2 loans are those for which credit risk has increased significantly since origination.

RBI, the European bank with the largest exposure to Russia, logged an 18.88% stage 2 ratio — loans at increased risk of default as a portion of total gross loans. The bank recently came under fire for seeking to acquire a stake in a construction company in a deal meant to cut its exposure to Russia. It was forced to abandon the transaction amid concerns that it could breach US sanctions given Strabag's link to a sanctioned oligarch.

Meanwhile, OTP Bank recorded a stage 2 loan ratio of 13.31% and had the highest nonperforming loan (NPL) ratio among the sampled banks, at 4.68%, up 90 basis points from the end of 2023.

Most of OTP Bank's problem loans are generated from its large operations in Hungary, Bulgaria and Croatia, as well as in weaker operating environments such as Russia, Ukraine and Uzbekistan, Moody's said in a May 3 bulletin. Moreover, OTP bank has historically had higher NPL levels than its domestic peers since it runs its own workout unit, OTP Factoring, resulting in the longer retention of these loans.

The war in Ukraine continues to be a source of volatility for many key markets in central and Eastern Europe as they are geographically closest to the conflict, Fitch Solutions said in an outlook report.

Yet many large European banks still operate in Russia, prompting the European Central Bank to pressure banks to expedite their exit. US Treasury Secretary Janet Yellen, in a Reuters interview, also warned lenders that they face an "awful lot of risk" amid plans to tighten secondary sanctions on Russia.

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After OTP Bank, Italy's Banca Monte dei Paschi di Siena SpA experienced the steepest deterioration in asset quality as its NPL ratio increased 63 basis points. Larger Italian peer UniCredit SpA followed with a 46-basis-point increase.

UniCredit has the second-largest exposure to Russia among EU banks after RBI. Its CEO, Andrea Orcel, said the bank plans to step up the reduction of its exposure, which has already shrunk by 67% over the last two years.

Fabio Panetta, Bank of Italy governor and ECB policymaker, has urged Italian banks to cease operations in Russia despite "objective difficulties." He said staying in the country could cause a "reputational problem."

Italian banks could also potentially face further deterioration in loan quality in the medium term due to high interest rates and possible funding difficulties at a time when the Eurosystem is reabsorbing excess liquidity, the Italian central bank said in a financial stability report. The regulator also projects the loan default rate to edge up to 2.8% on average in 2025, driven by the higher cost of debt.