* Bad loans remain a problem given weak economies
* Euro zone debt crisis spills over to East
* Hopes for regional economic recovery in H2
By Michael Shields and Michael Winfrey
VIENNA, Jan 15 This year is shaping up as a survival test for banks in central and eastern Europe. It could bring recovery for those which have strengthened their balance sheets and cripple others which have not.
Lending growth is slowing in sluggish economies, bad loans are on the rise and margins are narrowing from the heady days before Europe's debt crisis infected emerging markets to the East, senior bankers said on Tuesday.
But despite its woes, the region still boasts faster growth than the sickly euro zone, its countries are less indebted and banks can make better profits there than in the West.
The financiers tried to quash talk they were turning their backs on a region that depends more than average on bank lending to finance business.
Andreas Treichl, the outspoken chief executive at Austria's Erste Group Bank, told reporters this is the year that markets will see which banks did their homework by building up capital and liquidity and cutting costs during the crisis.
"We are by no means at the end of the development that started in 2008," he told reporters late on Monday.
"We still live in very insecure times and I think those times are perfect to show who is really good and who is not as good. The good ones will get better in 2013 and the bad ones will get worse."
He said buoyant financial markets were getting ahead of actual developments in Europe.
Erste, which vies with Raiffeisen Bank International to be CEE's second-biggest lender after UniCredit , underscored the risks by taking a 300 million euro goodwill writedown, mainly on its Romanian unit.
Raiffeisen Chief Executive Herbert Stepic said the CEE region remained Europe's growth engine even though it had not escaped the impact of the West's sovereign debt woes.
But he also said the sector's non-performing loans (NPLs) had still not peaked in CEE.
"A slower but continued growth of NPLs and NPL ratios - also driven by lower loan growth - seems the most likely scenario in most CEE markets," he told reporters on the sidelines of a Euromoney conference on the region's outlook.
SOME BRIGHT SPOTS
This was especially true given the weak economic growth outlook for the last quarter of 2012 and first quarter of 2013, he said, citing in particular a substantial slowdown of growth momentum in central Europe alone.
He saw loan growth slowing but no signs of so-called "deleveraging", in which banks - under pressure from regulators - cut back business in a move to conserve capital.
Bad loans in CEE will remain a potential problem for banks until next year if not longer, although margins will outshine those in the western part of the continent, UniCredit said.
"Asset quality is a source of risk, at least until 2014," according to its annual CEE sector report.
It is not all bad news, however, for a region that has seen no major bank failures.
Officials hailed global regulators' decision this month to ease rules on liquidity buffers big banks must hold.
Banks were given four more years to build a backstop against future financial shocks and were allowed a wider range of assets, including stocks, residential mortgage-backed securities and lower-rated corporate bonds.
"For sure this will be a push for the improvement and the growth in loans," said Gianni Franco Papa, head of central and eastern Europe for UniCredit.
And ratings agency Moody's said the creditworthiness of CEE sovereign borrowers would likely remain steady in 2013 despite the region's vulnerabilities.
One of the biggest challenges for regional rivals including KBC, Societe Generale and Intesa SanPaolo is continuing to shift their business models to depend on local CEE financing raised via deposits and debt issues.
This is a departure from pre-crisis days when banks provide cheap foreign financing to their CEE operations.
UniCredit's Papa said the idea was to strike a balance where banks can support credit activity and growth in countries.
And if economies pick up, will local deposits suffice?
"This is something we have to look at but for sure we cannot go back to the model before the crisis," he said. (Additional reporting by Angelika Gruber; Editing by David Cowell)