Austria’s move this week to impose tight curbs on its banks’ future lending in central and eastern Europe has thrown into sharp relief the potential impact of the eurozone’s sovereign debt crisis.

To protect its own triple A credit rating, Vienna has instructed Erste Bank, Raiffeisen Bank International and Bank Austria, a subsidiary of Italy’s UniCredit, to boost capital reserves and limit cross-border loans.

The decision came just days after UniCredit announced a review of its extensive businesses in the region, and Germany’s Commerzbank said it would restrict new loans to Germany and Poland only. The Latvian authorities on Tuesday rescued Krajbanka, the country’s ninth biggest bank, after Lithuania’s bail-out last week of Snoras, its fifth-largest lender.

These are the most difficult times for banking in central and eastern Europe (CEE) since the immediate aftermath of the end of communism. In the 20 years to 2008, west European lenders came to dominate the sector in most countries except Russia. With the eurozone in crisis, many lenders are pulling in their horns even more drastically than they did when the global turmoil first struck in 2008-09.

As the charts show, cross-border credit is poised to fall rapidly – perhaps by 20 per cent according to Canada’s RBC. The biggest economies, led by Russia and Poland, might respond by accelerating the development of domestic financial resources: others will seek new foreign investors, possibly from Russia. The most vulnerable states will struggle, however, with their main external funding source reduced just as their main external source of growth, exports to western Europe, runs out of steam.

“We cannot stop deleveraging, we have to manage the process,” says Erik Berglof, chief economist at the European Bank for Reconstruction and Development. “But I don’t think we should have the illusion that banking in the region will look the same after this.”

For many investors, the region’s fundamental advantages remain. Despite the turmoil of the past three years, economies, headed by Poland, are still competitive exporters with vibrant consumer markets. The EBRD forecasts that the region’s GDP will grow 4.4 per cent this year and 3.2 per cent in 2012. This is far less than it forecast, even in the summer, but is streets ahead of a stagnating eurozone.

Also, bank deleveraging may now come as less of a shock than in early 2009, when the region was spooked by fears of a post-Lehman bank pull-out. Then, the global crisis struck economies riding high on cheap credit.

Now, the eurozone crisis is buffeting countries that have suffered three years of recession or slow growth and financial retrenchment. In most CEE countries new bank credit has shrunk to a trickle. The burden of low foreign exchange rates weighs heavily on borrowers trying to service debt in depreciating local currencies, for example in Hungary, Poland and Romania.

But things could also get worse. Three years ago the EU could invest time and money in CEE – working closely with the International Monetary Fund on rescue loans for seven CEE states and encouraging western banks to stay in the region. Now, only Ukraine has a fully fledged IMF programme in place. Romania and Serbia have precautionary accords and Hungary last week announced that it was also seeking one. But, with the EU fighting much bigger fires in the eurozone, there is little energy left for the east.

Mr Berglof wants a new version of the 2009 “Vienna initiative”, which promoted regional banking co-ordination. He says although the EU said the interests of all countries should be taken into account in implementing new bloc-wide banking rules, western national regulators are, in practice, tempted to put their own countries first.

Differences between countries are critical. West European banks see the central European heartland of Poland, the Czech Republic and Slovakia as sound, core territories. In Poland, banks that wish to pull out find buyers, as Allied Irish Bank did this year when it sold Bank Zachodni WBK, Poland’s fifth-largest lender, to Spain’s Santander for €4bn.

But institutions which ploughed east as far as Kazakhstan are now cautious about the former Soviet Union and south-east Europe. Oil-rich Russia can support its own banks and even encourage them to invest abroad. But Ukraine is vulnerable, as are the smaller Balkan states, where Greek banks are cutting back because of the crisis in Athens.

Hungary, once the foreign investors’ darling, has fallen far out of favour, with banks turning against its economic policies, including a foreign exchange mortgage law.

Which banks will go as far as pulling out altogether, such as Allied Irish, will depend more on the condition of parent groups than on their local subsidiaries. Clearly, the possible sellers include banks based in crisis-hit eurozone countries, such as Greece, Italy, Spain and Portugal. As one French banker says: “It’s not to do with the region – it’s to do with the eurozone.”

The Financial Times