Emerging Markets Could Be Hit Hard if European Banks Melt Down

By Mark Gongloff

Emerging markets, once a reliable source of hair-raising market volatility, have in the past decade become veritable safe havens. They managed to hold up fairly well during the 2008 credit crisis. They may not do so well in the event Europe collapses, however.

RBC Capital emerging-market analysts today point out that, while US banks had a relatively small share of lending into emerging markets heading into the 2008 crisis, European banks take up a far bigger share. That means European bank collapses could cut off a key source of emerging-market funding, hitting growth:

Examining the latest September BIS report with data running through March-2011, one particular issue stands out — European bank lending into EM is comparatively much larger relative to the other two major developed country banking systems amounting to US$3.4tn vs. US$299bn and US$727bn for Japanese and U.S. banks, respectively.

Interesting to point out from the data, it is fair to assume that EM financial systems were relatively resilient to deep stresses in the U.S. financial sector in 2008/2009 likely because U.S. bank lending into EM was on a relatively smaller scale.

However, if European banks were to widely undergo similar financial stresses, the negative consequences for EM, particularly a more significant growth shock, could be much more material, particularly if there is a pro-longed credit squeeze.

EM accounts for ~18% of European banks’ total foreign loan book, which is slightly below the equivalent for U.S. banks (22%), with the biggest exposure in the EEMEA region (51% of total EM exposure), followed by Emerging Asia (26%) and Latin America (23%).

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[F]oreign bank lending originated by European headquartered banks (including their local subsidiaries) is unsurprisingly significant in Emerging Europe and Africa and the Middle East (90%) – basically Europe’s Emerging periphery, so these regions would likely be most impacted if availability of credit were to shrink significantly. However, European bank lending is also quite significant in both Emerging Asia and LATAM, with these regions sourcing 60% and 68%, respectively, of their foreign bank credit from European banks.

This is another reason, along with a China slowdown and a simple need to raise cash, we could be seeing emerging markets losing their safe-haven status during the current unpleasantness.