Financial crisis: testing the relationship between foreign banks and the new EU members

Abstract

This paper discusses the impact of the recent financial crisis on the relationship between the domestic authorities of new member states and the foreign banks that dominate their financial sectors. Foreign banks played an adverse role during the unsustainable pre-crisis credit booms that rendered certain EU10 economies very vulnerable to crisis. However, they also supported the most affected EU10 economies through the acute phase of the crisis, when new capital and liquidity was essential for the success of domestic and international stabilization programs. It thus seems that the crisis test had proven the viability of the EU10 model of financial integration. However, there are also signs of heightened political risks that tend to be disregarded by economic analysis. This paper provides early evidence from Hungary and Latvia demonstrating that these risks are not entirely covered by EU membership. Domestic tax and regulatory policy changes may have a substantial impact on foreign subsidiaries in EU10 countries and thus strain mutual relationships more than expected. Therefore, it is yet to be seen whether the foreign-dominated banking model is resistant to the politics of hard times.