Initially, the still-evolving crisis in Europe was
read as being the result of excess public debt and
poor public finances. Though this debt was owed to
the banks, especially European banks, the latter were
seen as protected. Default on debt owed to them would
damage the financial system, worsen the real economy
crisis, break the Eurozone and end the euro. Governments
that had come together to constitute the Eurozone
and adopt a common euro would hardly opt for this
scenario stemming from a default by them that could
damage bank profitability. Using that argument, the
financial community worked overtime to call for action
that would save the banks at the expense of the countries
of the Eurozone and their populations.
It is now clear, however, that this strategy would
not work. Governments seeking to ''adjust'' through
austerity are finding their public finances worsening
rather than improving, eroding further their ability
to avoid a default on debt commitments. Thus, banks
are being required to take a haircut, currently set
at 50 per cent of loan value, up from 20 per cent
a few months earlier. This could get even higher.
Given the damage that this would do to bank profits
and balance sheets, a recapitalisation of European
banks is imperative, with the current overly conservative
estimate placing the funds required for that purpose
at €106 billion. In addition, with European regulators
set to agree on a revised core (tier one) capital
ratio of 9 per cent for their banks, this figure could
go up to €275 billion, according to Morgan Stanley.
As of now, banks are required to dig into their global
reserves (if any), approach the private markets for
debt and equity, as well as take support from governments,
through the European Financial Stability Facility
(EFSF). But with most European governments unwilling
or unable to provide funds, the EFSF's future strength
is still uncertain. Thus, a significant retrenchment
of still performing assets by European banks and a
persisting and possibly worsening real economy crises
seems unavoidable as of now.
This has led to much discussion on how a European
banking crisis would affect the rest of the world.
Our concern here is with the impact on developing
countries, especially the developing countries or
the ''emerging markets'' in Asia exposed significantly
to global banks.
It is now well accepted that one of the consequence
of financial globalization has been the increased
presence of global banks in developing countries and
an increase in their role as lenders in these countries.
This process has, of course unfolded to different
degrees in different regions of the world. Between
1995 and 2005, the share of foreign banks in total
bank assets rose from 25 to 58 per cent in Eastern
Europe and from 18 to 38 per cent in Latin America,
though even by that date the increase in East Asia
and Oceania was much less (from 5 to 6 per cent).
With this increase in presence, the share of foreign
banks in lending to non-bank residents has been rising.
Since the mid-1990s (and by 2009) the share of foreign
banks in credit to non-bank residents rose from 30
to 50 per cent in Latin America, to nearly 90 per
cent in emerging Europe, but is still at about 20
per cent in emerging Asia.
Chart
1 >>
Click to Enlarge
As of the end of the second quarter of 2011, banks
in countries reporting to the Bank of International
Settlements (BIS) had foreign claims of $27.3 trillion
outstanding. Though a dominant share ($20.1 trillion)
of these accumulated claims was in the developed countries,
the developing country share ($5.1 trillion) was by
no means meagre (Chart 1). What is particularly noteworthy
is that the international banks involved are predominantly
European. Around 70 per cent of the foreign claims
of the global banking system is on account of European
banks. Greater financial integration in Europe is
one obvious reason. Of the $20.1 trillion claims on
the developed countries, $12.3 trillion is in European
developed countries, as compared with just $5.6 trillion
in the US.
But another part of the reason is that European banks
faced with increased competition at home are now seeking
out developing countries to expand business and sustain
profitability. Close to 20 per cent of the exposure
of banks abroad is in developing countries, and this
is true of European banks as well (Table 1). Given
the greater role of European banks in total international
funding and the importance of a few developing ''emerging
markets'' as recipients of capital, this is of significance.
The concentration of emerging market exposure in banks
from one region increases the vulnerability of both
these banks and their clients. But as discussed below,
given the asymmetric nature of the relationship between
foreign banks and their emerging market clients, this
vulnerability is the greater for the latter, especially
in the context of the current crisis in Europe.
Table
1: Foreign exposure of banks by region (Per
cent) |
|
00
|
All
banks |
European
banks |
| Developed |
73.8 |
74.7
|
| European Developed |
45.3 |
49.3
|
| US |
20.7 |
20.0
|
| Offshore Centres |
7.1 |
5.8
|
| Developing |
18.5 |
18.9
|
| Dev'ing Af
& ME |
2.2 |
2.6
|
| Dev'ing Asia
& Pacific |
6.5 |
4.9
|
| Dev'ing Europe |
5.2 |
6.9
|
| Dev'ing
LA&C |
4.6 |
4.5
|
Table
1 >>
Click to Enlarge
In the current context, the vulnerability of the developing
countries, as demonstrated by the experience during
the 2008-09 crisis, comes especially from one source.
Having to cover losses at home, recapitalise themselves
and improve the risk profile of their lending, European
banks are likely to look to transferring profits and
retrenching assets in their global operations. Emerging
markets are bound to be affected by such moves. Among
emerging markets, those in the Asia-Pacific, normally
presented as relatively ''decoupled'' from the developed
West, are just as vulnerable. As much as $1.8 trillion
of the $5.1 trillion of global banking foreign claims
located in developing countries are in the Asia-Pacific.
Chart
2 >>
Click to Enlarge
The disconcerting feature of these claims is that
they seem to have been driven to a substantial degree
by short-term supply side developments in the developed
countries. As Chart 2 shows, foreign claims on the
Asia-Pacific developing countries rose by $547 billion
during the period 2000-2006, when there occurred a
supply side driven surge in capital flows across the
globe. Even during the crisis period stretching from
2007 to the middle of 2009 foreign bank claims in
the region increased by $290 billion. And when the
post-crisis liquidity infusion made available cheap
capital in large quantities to the banking system,
the Asia-Pacific developing countries were the locations
for an expansion of foreign bank claims to the tune
of $596 billion in just two years. A capital surge
of this kind, that provided additional grounds for
the ''decoupling'' perspective, makes the region even
more vulnerable to a capital outflow or a mere cutback
in lending by foreign entities.
Chart
3 >>
Click to Enlarge
Given what we noted earlier, this vulnerability is
greater because of the importance of European banks
in the region. The share of European banks in these
claims in the developing Asia-Pacific rose from 53
to 58 per cent between 2000 and 2006, and has since
fallen to 52.6 per cent (Chart 3). Part of the reason
for that decline is the fact that the liquidity infusion
into the banking system has been far more in the US
than in Europe in the aftermath of the crisis. But
it is also a reflection of the fact that European
banks have been turning more cautious and possibly
retrenching assets when they mature, to transfer funds
to their parent entities.
Table
2: Accumulated Foreign Bank Claims as a
Percentage of GDP in Emerging Asia |
| 00 |
China |
Indonesia |
India
|
Korea |
Malaysia |
Thailand |
2005 |
3.3 |
9.0 |
9.7 |
24.2 |
52.7 |
18.6 |
2006 |
4.7 |
9.3 |
12.3 |
27.1 |
54.1 |
20.1 |
2007 |
6.1 |
10.8 |
16.0 |
31.6 |
55.9 |
18.2 |
2008 |
3.9 |
9.4 |
15.1 |
29.3 |
44.5 |
17.1 |
2009 |
4.6 |
10.0 |
14.9 |
37.5 |
53.6 |
21.7 |
2010 |
6.1 |
10.5 |
15.3 |
31.4 |
52.6 |
22.9 |
Table
2 >>
Click to Enlarge
That being said, how important are these foreign bank
claims to the Asia-Pacific developing countries? It
is indeed true that in many of them the annual flows
of capital that those claims represent are small when
compared to the aggregate annual flow of debt, equity
and other claims. However, as accumulated claims these
do constitute a significant amount relative to GDP
in most Asian emerging markets, excluding China (Table
3). At 15-20 per cent in India and Thailand and as
much as 30-50 per cent in Korea and Malaysia, these
accumulated claims are a source for concern. Any sudden
retrenchment can create liquidity as well as foreign
exchange difficulties.
This vulnerability needs to be assessed in the context
of the collateral damage that a banking crisis in
Europe can result in. It would worsen the recession
in Europe, which is an important destination for exports
from Asia. The recession in Europe would in turn precipitate
the double dip that can damage Asia's foreign exchange
earnings and growth even more. And finally, the European
banking crisis could trigger a global crisis, not
just in banking but in the financial sector generally,
given the multiple institutions and instruments through
which financial markets are interlinked today. If
that occurs, what matters is the aggregate exposure
of the Asia-Pacific to global capital: and that is
indeed substantial. Asia too needs to look to protecting
itself in the near future.
