Blackstone’s Baltic banking bet

Baltic banking has had a bad press in recent years. Since 2015, the sector has suffered a succession of money laundering scandals relating to its post-communist predilection for handling cash from the former Soviet Union.

Initially it was local Latvian non-resident banks such as ABLV that fell foul of the US authorities, but by late 2018 the fallout had spread to encompass some of the Nordic groups that have dominated banking in the region over the past 20 years, notably Danske Bank and Swedbank.

Even by the standards of central and eastern Europe (CEE), the Baltic markets are tiny: the largest, Lithuania, has a population of 2.8 million, while Estonia has only 1.3 million. This might not seem the most attractive prospect for one of the world’s largest investors.

Yet at the same time as Danske admitted its Estonian branch had handled more than €200 billion of suspicious transactions before its closure in 2015, Blackstone announced plans to pay $1.2 billion for 60% of Luminor, the Baltics’ third-largest banking group.

Created a year earlier through the merger of the regional operations of two departing Nordic groups, DNB and Nordea, Luminor at the time was an unwieldy organization struggling to combine the operational systems of its two parents.

In its first year under new ownership, the process of merging systems and disentangling the bank from its former shareholders again took priority – but by the end of last year, Luminor was ready to embark on a renewed push for growth and profitability.

To lead the charge, Blackstone brought in one of the big hitters in CEE banking. Until last year, Peter Bosek was chief retail officer of Erste Group. Having joined the bank in 1996, a year before the arrival of legendary chief executive Andreas Treichl, he was a key part of the team that transformed it from a small Austrian savings bank into a CEE powerhouse.

He was also one of two internal candidates to succeed Treichl when the latter finally stepped down in 2019, but he lost out to Bernd Spalt, the group’s chief risk officer. Nine months after his rival took over the top job, Bosek announced his move to Luminor.

When Euromoney catches up with him, he has been in Tallinn for two months – the first time in his career he has worked outside Vienna. So how is he finding life on the Baltic coast in winter?

“Tallinn is very beautiful,” he says cheerfully, moving his webcam to show the frosty blue sky outside his office window. “The old town is outstanding and I love to walk on the beach at the weekend. The combination of sea, beach and snow was completely new to me.”

The move from Erste to Luminor is almost as a big leap as from the Danube to the Baltic. Erste serves 16 million customers in six countries from Czech Republic to Montenegro and boasts a balance sheet of €277 billion.

Luminor has operations in all three Baltic markets but is tiny by comparison, with around 900,000 customers and a balance sheet of just €14.9 billion. It is also small compared to the Baltic operations of Swedbank and SEB. The former has total assets of €36.6 billion in the region, while SEB has €20.3 billion.

This matters because received wisdom says that these markets are too small to support more than a couple of big universal players – indeed, that was one of the main reasons DNB and Nordea gave up on the region.

Competition has also intensified in recent years with the rise of nimble locals such as LHV Bank and Coop Bank in Estonia and Citadele in Latvia, as well as a plethora of home-grown and international fintechs. Revolut added Estonia and Latvia to the growing list of countries where it offers banking services in March, after starting its rollout in the region in Lithuania last year.

Nevertheless, Bosek insists he is “absolutely not worried” that there is a place for Luminor.

“To be honest, I’ve never even thought about it from this angle,” he says. “It’s true that the markets are not huge compared with the UK or Germany, but when you look at the economies of these three countries, there is a lot of room for banks to grow here.”

Certainly, the Baltics can lay claim to a good macroeconomic story. In the five years before the start of the Covid crisis, the three countries were among the fastest growing in the eurozone, well ahead of most of core western Europe. Estonia’s economy expanded 19.9% between 2015 and 2019.

They have also weathered the pandemic well so far, thanks in part to generous government support. The average subsidies provided to businesses and citizens in the Baltics over the past year was equivalent to 10% of GDP, versus a European Union average of 8%.

As Bosek notes, bank profitability has also been impressive in recent years, for local banks as well as for the big Swedish players.

“From a banking perspective, the Baltics is the most profitable region to be in,” he says. “We are seeing returns on equity here of over 20%, while a bank like LHV has a market valuation of 2.8 times book value.”

On that front, Luminor has a way to go to catch up. The group posted a return on equity of 3.1% in 2019, a figure that slipped to 2.0% last year during the pandemic.

Bosek’s first task will be to bring the bank into line with its regional rivals. So where does he see opportunities to make inroads in the Baltic markets?

On the corporate side, his main target is local businesses that want the speed and flexibility that banks based outside the region may struggle to provide.

“Clients like to have local decisions, especially in the corporate sphere,” says Bosek. “At Luminor, decisions are taken in the Baltics – we don’t have to report to any kind of headquarters. I think this is a competitive advantage.

“Given that we’re operating in all three markets and that we have a very strong capital position, from my perspective I’m the only option for local corporate clients who want an alternative to the Swedish banks.”

Clearly, some of these companies may need financial help when the economic recovery from the Covid crisis gets underway – which Luminor is confident will happen in the second quarter of the year – and governments start to wind down pandemic support packages.

Bosek says supporting corporate clients through this transition will be a priority for the bank. For him, the biggest challenge will be dealing with the erosion of equity as firms book losses for 2020. Coming up with ways to address this will be crucial for all banks, he adds.

“Obviously we can’t offer equity to our clients, but maybe we can find ways to broker equity,” he says. “Also, with established clients we maybe need to be willing to accept lower equity levels to help them overcome this situation – because if we as a banking industry are not willing to grant loans, there is no hope.”

As well as corporates, Bosek is keen to expand Luminor’s reach among small and medium-sized enterprises. But his real enthusiasm, perhaps unsurprisingly, is for his traditional area of focus – retail.

Consumer lending may have taken a knock during the Covid crisis, but demand for mortgages has surged over the past year, particularly in Estonia and Lithuania. Given the relatively low penetration of mortgages in these markets, Bosek is confident that the boom has several years to run.

He is even more excited about the prospects for developing Luminor’s asset management offering, an area where he sees huge potential for growth.

Deposits in the Baltics soared last year as lockdowns slowed consumption and uncertainty encouraged households to save. In the fourth quarter, the percentage increase in term deposits in the region was the highest in Europe. Luminor’s deposit base grew by 15.7% in the 12 months to December.

As Bosek notes, this creates the perfect conditions for an asset management boom, especially among a new generation that has grown up in a zero or even negative interest rate environment and is finally waking up to the possibilities of investment.

“Over the past three to four years, banks were always trying to convince their clients – and particularly younger clients – to be more interested in investing in securities but without success,” he says. “Now suddenly we’ve seen it take off, driven by social media, and banks need to be part of that trend.”

For Luminor, this means selling “very simple, transparent” asset management products, says Bosek – and preferably ones that give retail investors some protection against market swings.

“I believe it’s particularly important that we structure products so that clients are able to save and invest on a monthly basis,” he says. “Market volatility has been continuously increasing so convincing our clients to make one-time investments wouldn’t be right for them at the moment.”

Unlike both its local and Swedish rivals in the Baltics, Luminor does not currently have an asset management arm and Bosek has no plans to develop one. Instead, he is looking to offer products from third-party providers and has already started discussions with several potential partners.

“One of the great advantages of Luminor is that I have no history to defend or to protect,” he says. “I’m completely free in my product offering.”

In the past some Baltic bankers have argued that the relative lack of sophistication of local retail clients – a supposed legacy of the region’s communist past – means appetite for asset management is limited. Bosek is unconvinced.

“I don’t think there is any difference between the Baltic region and Germany or Austria in terms of the know-how of clients,” he says. “It’s not news to anyone that we are lacking financial literacy in Europe, but that’s true for the whole continent.”

One area where the Baltics are definitely not lagging, of course, is digitalization. Estonia, the birthplace of Skype and a pioneer of digital government, is famously technologically advanced, while Lithuania has made a name for itself over the past five years as a fintech nursery. Even regional laggard Latvia is ahead of much of the rest of CEE when it comes to technology.

As Bosek notes, this can be a mixed blessing. “It means the room for making a mistake here is very limited because there will be an immediate reaction from clients,” he says. “That’s good because it keeps you awake.”

Unsurprisingly, given that creating the bank involved merging two operating systems and then, after the acquisition by Blackstone, carving them out from those of its parent groups, there has been little opportunity for digital development at Luminor over the past three years.

Following the migration of customers in all three Baltic markets to new digital platforms last year, however, the bank’s technology platforms are now fully independent of those of DNB and Nordea (although the two groups have each retained a 20% stake in the new entity).

That has set the stage for a big digitalization drive. “We are at the beginning with digital banking, but this is definitely an area where we will invest heavily over the coming years,” says Bosek.

It is a challenge after his own heart. At Erste he was one of the prime movers behind the creation of George, the groundbreaking pan-regional digital platform launched by the group in Austria in 2015. It has since been rolled out in all but one of its six CEE subsidiaries, most recently in Hungary in February.

So, does Bosek have plans to build a Baltic George – a Georgs or Jurgis, perhaps? Definitely not, he says.

“Everyone is expecting me to come up with something similar at Luminor, but that’s not what I want to do,” he says. “George is great, but it wouldn’t be right to do a copy and paste. It is a different region and a different environment.”

It seems safe to assume that Luminor’s budget is also smaller than that of Erste, but, as Bosek notes, one of the biggest bonuses for smaller lenders has been the emergence over the past five years of off-the-shelf digital banking solutions from the likes of IBM, Amazon and Oracle.

“As a small bank the only chance I have is to partner with the big IT guys,” he says. “I think that’s the only way forward for banks in the future from a tech perspective.”

In January, Luminor announced a five-year agreement with IBM that will see the bank’s digital platform migrated to the US group’s Cloud for Financial Services.

Yet while digitalization is key to Bosek’s vision for Luminor, he warns that technology by itself will not be enough to enable banks to ward off the threat from newer players such as PayPal, which in February announced plans to expand into areas such as savings and investment.

To do that, he says, they will need to rediscover their traditional advisory role. “Looking back at 20 years of digital banking, we started with simple online money transfers and then moved on to selling banking products,” he says.

“I think the next step will be adding simple advice for clients who want it – and this will make all the difference. Otherwise, you will do your banking with PayPal and in 10 or 20 years I won’t be here.”

At the same time, Bosek believes banks can learn from some of their new rivals. “I’m not very interested in what Swedbank or SEB are doing,” he says. “I know them very well and they know me very well, so watching them closely doesn’t add any value. I’m much more interested in watching other industries that are doing much better in terms of client service.”

He watched PayPal’s investor day in February with particular interest. “They have grown their client base dramatically, so they are clearly doing something right,” he says.

Bosek has also been indulging in some lighter viewing – although here again, he found some useful lessons for Luminor. A keen Netflix fan (his favourite show at the moment is US crime drama ‘The Blacklist’), he was annoyed to find that his Austrian account didn’t work in Estonia.

He was very impressed, however, with Netflix’s customer service. “I was able to press a button on the app and be put through to a call centre in Germany, where a very friendly lady was able to sort out my problems immediately,” he says. “So, I was very happy sitting in the darkness in Tallinn talking to someone who supported me in my digital experience.”

This seamless melding of digital and remote support is exactly what banks should be doing, he says. “Of course, you will do a lot of your banking by yourself, but if you need me then it should be very easy to get hold of me,” he says. “This is an area where we see a lot of room for improvement.”

As another example, he cites Skype consultations with bankers – something Erste has been offering for years that is not currently available for Luminor customers. “This is exactly the type of thing I want to do,” says Bosek.

Given his enthusiasm for technology and the fact that the reputation of Baltic tech is much higher than that of Baltic banking, does Bosek want to position Luminor as part of the tech story rather than the banking story?

Absolutely not, he says. “I would stick to the banking story. I’m proud to be a banker and I think banks shouldn’t pretend to be tech companies.”

What he would like to see is Luminor becoming a consumer brand. “It’s all about customer experience,” he says. “I think this is the mindset shift we should have in front of us, not trying to hide behind a different kind of industry and hoping that our market valuation goes up a bit.

“Some of my banking peers seem to think that if they have one developer and pretend to be a tech company, they can IPO next week.”

Bosek also warns against overreliance on technology, particularly in terms of data management. “It should never come to a situation where you get a bad feeling that I am making use of your data in a way you don’t like,” he says.

For this reason, he has always supported the EU’s General Data Protection Regulation (GDPR). “While it makes our life a bit complicated from time to time, it gives the banking industry a competitive advantage,” he says.

“The tech companies work on the basis that they provide services for free and in return they get your data for free. As a bank I am fully compliant with GDPR and it’s clear that I will never sell your data.”

He is also a traditionalist when it comes to bank branches. “As long as I’m here Luminor will have a branch network because it’s necessary to have a physical contact point,” he says. “I’m 100% convinced of that. Having a physical contact point is what differentiates us from the likes of N26 and Revolut.”

Luminor currently has 35 branches in its three markets. “It’s not huge, but it’s enough if they are in the right place,” says Bosek. “For me, the focus on the number of branches has always been a bit odd. I’m a banker not a real estate company.”

A new development he welcomes, however, is the increasing focus in the Baltics on environmental, social and governance (ESG) issues.

“It’s a huge topic in this region and I think it’s a great business opportunity for us,” he says. “It’s clear that we are going to see a transformation from traditional economies to green economies and that implies a huge need for capital, both debt and equity.

“For us in the banking industry it’s the best thing that can happen. What we need on our side is to build up know-how in this area, so it’s critical for banks to invest in educating their employees.”

Unlike some other players in the industry, Bosek is undismayed by the raft of regulation and legislation emerging from the EU on sustainability. “It is true that ESG brings a heavy regulatory burden, but as a bank that’s just something that you have to accept,” he says.

“Looking back, a lot of things that have happened in terms of regulation since the financial crisis had a very positive impact. The capital ratios of banks are in much better shape today than before the financial crisis, despite the pandemic.

“Did we like it that we had to build up capital? No. Was it the right thing to do? Yes.”