European Exposure to Emerging Markets
Ever since the sovereign debt crisis in Europe has retreated into the background, worries about European banks have quieted down as well. However, the recent EM currency crisis may bring them to the fore again. According to a recent analysis published by Deutsche Bank, the total exposure of European banks to emerging markets amounts to well over $3 trillion. Euro zone banks have some 70% of their capital and reserves at risk. Given that the average of loans outstanding that have become non-performing in past EM crises amounted to 40% of all loans (not a typo – that’s the average!), there is certainly some reason for concern. According to a Reuters report:
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“European banks have loaned in excess of $3 trillion to emerging markets, more than four times U.S. lenders and putting them at greater risk if financial market turmoil in countries such as Turkey, Brazil, India and South Africa intensifies.
The risk is most acute for six European banks – BBVA, Erste Bank, HSBC, Santander, Standard Chartered, and UniCredit – according to analysts. But the exposure could be a headache for the industry as a whole, just as it faces a rigorous health-check by the European Central Bank, aiming to expose weak points and restore investor confidence in the wake of the 2008 financial crisis.
“We think EM (emerging markets) shocks are a real concern for 2014,” said Matt Spick, analyst at Deutsche Bank. “When currency (volatility) combines with revenue slowdowns and rising bad debts, we see compounding threats to the exposed banks.”
The Deutsche Bank analysts said the six most exposed European banks – which they did not name – had more than $1.7 trillion of exposure to developing markets. In recent weeks, emerging market currencies have come under fire as China’s growth slows and the U.S. Federal Reserve winds down its stimulus program, with investors selling developing market assets in anticipation of higher U.S. interest rates.
In a bid to protect currencies, interest rates have been hiked in Turkey and elsewhere, but investors remain nervy, especially around the so-called “Fragile Five” economies of Turkey, Brazil, India, Indonesia and South Africa. An emerging markets crisis could hit banks in a variety of ways – a collapse in local currency can hurt reported earnings or capital held in the country; loan losses can jump as interest rates rise; or income from capital markets activity or private banking can fall.
