By Michael Winfrey
PRAGUE (Reuters) - Policymakers in emerging Europe should help banks resolve bad loans and find more local sources of funding to avoid the cycle of boom and bust fanned by an ownership model dominated by foreign lenders, the IMF said on Friday.
In a report on the banking sector in the European Union's eastern wing, the International Monetary Fund said non-performing loans would continue to rise in some states, impeding credit flows and denting profits in western banks operating there.
It said that, while conditions differed from country to country, authorities could remove legal and other obstacles to help lenders clear soured loans that in some had reached more than 20 percent of portfolios.
That has crushed loan growth and undermined recovery.
"Tackling the high non-performing loans that make banks in CESEE (Central, Eastern and South Eastern Europe) reluctant to extend new loans could provide an important offsetting effect on credit growth," it said.
"In addition, developing local capital markets could help create a source of stable, long-term domestic funding for banks," it added, saying that too much dependence on capital from foreign owners had triggered the boom-bust cycle.
Foreign banks - notably from Austria, Italy and France - dominate a region that stretches from the Baltic to the Black Sea after many countries sold their banks into private hands following the fall of the Iron Curtain.
The IMF said that, from 2003 to 2008, funds provided to the region grew fivefold to 646 billion pounds ($1 trillion), sparking a lending boom that created real estate and other asset bubbles.
Those popped following the collapse of Lehman Brothers in September 2008 and the subsequent turmoil on global markets, leading to an outflow of around one third of those funds.
A coordinated effort by banks and policymakers known as the Vienna Initiative allayed fears of a cross-border banking crises. But the IMF said the foreign funding had not helped growth.
"In good times it facilitated unsustainable credit booms, which were difficult to control for policymakers. In times of tight global liquidity, it exacerbated the retraction of credit supply, again with little scope for domestic policymakers to counteract," it said. "There is no evidence that greater access to foreign funding improved the economic growth performance in CESEE over the cycle."
The IMF also said new global rules on banks' capital buffers could cause some Western European lenders to cut exposure to their emerging subsidiaries "in excess of what would be considered 'healthy' deleveraging".
But it said results showed that, for the five largest banking groups in the region, their businesses in eastern Europe were substantially more profitable than those in the West.
(Editing by John Stonestreet)