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A bearish direction for Polish banking?

Foreign currency loans and investments made in good times put banks at risk.

The signs of trouble are beginning to appear. Although the overall number of non-performing loans is 4.4 percent, lower than at the end of 2007, the number of problematic corporate loans is increasing.

“The economic crisis was the first to hit companies. Households will be affected later,” said Krzysztof Mrowczynski, an economist with BPH Bank.

Compounding the potential crisis, many companies engaged in currency speculation, taking out options on currency hedges. This made sense last year when the zloty looked set to continue increasing in strength, but the holdings now threaten some companies with bankruptcy. Poland’s Financial Supervision Authority estimates that companies could face losses of about 15 billion zlotys ($4 billion), about one-fifth of all corporate profits, on ill-timed hedges.

Banking regulators argue that Poland’s banks are still well capitalized, and that the industry faces fewer troubles than banks in areas like the Baltics, the Balkans and Hungary, which have been hit much harder than Poland by the crisis.

“The situation is manageable,” said Krzysztof Pietraszkiewicz, head of the Polish Banking Association.

Governments and regulators from across the region are increasingly concerned that investors and analysts are seeing central Europe as a whole, and treating relatively stable countries like Poland and the Czech Republic as potentially toxic because they happen to be in the same neighborhood as economic basket cases, such as Latvia and Ukraine.

A joint statement put out by banking regulators in Poland, the Czech Republic, Slovakia, Bulgaria, Romania and Hungary said: “Each of the CEE member states has its own specific economic and financial situation and these countries do not constitute a homogeneous region. It is thus important first to distinguish between the EU member states and the non-EU countries and also to clarify issues specific to particular countries or particular banking groups.”

So far the 2008 results of Polish banks released in recent weeks show a sector that still looks quite healthy. Overall, banks earned 14.8 billion zlotys (about $4 billion) last year, up from 13.7 billion zlotys in 2007. Those numbers are a lot more robust than in the United States or in Western Europe, where governments have had to step in and rescue imperiled banks.

But there are warning signs. In the fourth quarter, many banks increased their reserves to cover potential problem loans, and analysts expect profits to drop by about one-third this year as the crisis begins to bite. And the problem of a sagging zloty and its malevolent effect on borrowers is nowhere close to ending.

“In the long run, we expect asset quality deterioration if the currencies stay at this level for a longer period,” says Gabiela Wercher, head of investor relations at Austria’s Erste Bank, which expanded aggressively in central Europe over the last decade.

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For more on the global economic crisis:Click here for the full report