Institutional banking in Central Europe has been facing significant difficulties. The supply of certain product groups has been significantly reduced. Credit margins offered to firms before the slowdown do not cover the cost of risk identified later. The profitability of many investments has turned doubtful with growing funding costs. Last but not least, that demand for investment finance from companies has fallen as many anticipate future difficulties and do not want to take additional risk. This has resulted in a significant drop in corporate banking revenue in many countries in the region.
The problem is exacerbated when the large credit facilities expected by some companies that are facing problems are hard to fund by banks facing problems of their own in the form of liquidity and risk-management issues.
Since 2008, corporate risk-management operations in banks have diminished dramatically. Dealers in derivatives from many banks used to sell their clients products that mostly suited their sales plans, not the clients’ risk profile. On the other hand, a number of company CFOs have found an interesting way of trying to improve their performance. Instead of hedging enterprises against the risks arising from their core business, they turned to “betting” on future forex rates with banks, hoping for the long-term trend of an improving forex rate to continue. Instead of winning, however, many of them have had to face enormous losses.
As a result, both parties in such transactions lost mutual trust. Banks are afraid that other derivatives will start to be more like a gamble than effective hedging tools, while enterprises are concerned that “interesting” treasury products may actually increase their risk instead of mitigating it. When applied in an appropriate manner, however, derivatives may certainly help in reducing business risk. First, though, they need to be used intelligently, and parties to the transaction must regain their trust in one another.