Banking Accidents Waiting To Happen

by: Acting Man

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. Eurozone 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:

“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.

(emphasis added)

The Eurostoxx bank index doesn't reflect much concern yet, but its recent breakout was possibly a false breakout (it is too early to tell for sure, but the chart looks slightly ominous). Meanwhile, it should also be pointed out that annualized true money supply (TMS) growth in the euro area has declined to 5.8% in December from 6.5% in November, which is quite a notable slowdown. The decline in bank credit growth to the private sector is evidently beginning to take its toll. Not surprisingly, in recent years the emergence of crisis conditions in Europe has always coincided with sharp slowdowns in money supply growth.

Eurostoxx bank index – still near its recent high, but the breakout may turn out to be false.

European banks have lent $3.4 trillion to emerging markets (chart via Deutsche Bank).

Euro area banks – EM exposure as a percentage of capital and reserves – down from its 2007 highs, but still plenty.

As Zerohedge recently reported, Italy has decided to employ an unusual accounting trick to shore up the capital of two of its largest banks (Unicredito and Intesa San Paolo). It will revalue the central bank's assets and force the banks to sell their stakes in the central bank – namely to the central bank itself. The banks will pocket € 3.5 billion as a result. This is certainly an entirely new level of the fiat money system Three Card Monte. We're just not quite sure yet who is going to end up paying for this (Italian tax payers? Holders of the euro?).

China's Foreign Credit Liabilities

Meanwhile, the press lately reports more and more often that after expanding credit by an estimated $15 trillion over the past five years, China may soon have to face the music in terms of growing defaults. The shadow banking system certainly looks wobbly, and China's banks are involved in it up to their eyebrows, as it allows them to circumvent restrictions that hobble their lending otherwise. However, it is not just in China itself that banks have amassed large exposure to what look like increasingly dubious business ventures.

Due to being exposed to Bernanke's ZIRP via the currency board, banks in Hong Kong have also sought to employ capital in what must have looked like greener pastures. A recent report by Jefferies' chief global equity analyst sheds some light on the eagerness with which they have stepped aboard what could soon turn out to be a capsizing boat.

The chart below shows the extent to which the net claims of Hong Kong banks on customers based in Mainland China have grown, as a percentage of the territory's GDP. As can be seen, all of the growth in credit exposure has taken place in the post 2008 crisis era when credit expansion in China went into overdrive and Bernanke imposed ZIRP and started the Fed's "QE" operations.

The fantastic growth of net claims of Hong Kong banks on customers based in Mainland China (source: Jefferies).

One wonders how well Hong Kong's bankers are sleeping these days. In this context note also a recent report by Forensic Asia on HSBC, which concludes that the bank may be overstating the value of its assets by up to $92 billion (HSBC is headquartered in the UK, but has extensive business interests in Asia):

“HSBC Holdings Plc, Europe’s largest bank, may be overstating its assets by as much as $92.3 billion and need to raise capital, according to analysts at Forensic Asia led by Thomas Monaco.

Loan loss reserves, tax assets and pension plan assets at the London-based bank are “questionable,” Monaco and Andrew Haskins wrote in a note to clients on Jan. 14, rating the bank a sell. The firm may need as much as $111 billion of capital, they wrote. HSBC spokeswoman Heidi Ashley declined to comment.

New Basel III rules on capital, “coupled with asset valuation concerns, lead us to conclude that HSBC’s stated capital ratios are substantially weaker than the group would have investors believe,’ the analysts wrote in the note.”

(emphasis added)

That certainly makes the bank's recent decision to limit cash withdrawals by its UK customers even more suspicious than it already was. HSBC's (NYSE:HSBC) stock is still trading at a very high level, but it won't take much for it to break below the support shelf established over the past year or so:

HSBC weekly – after trending sideways for more than a year, the stock looks as though it may be about to break down.


In light of the still evolving EM crisis (Deutsche points out that EM credit crises have traditionally occurred right after currency crises) and the potential for China's credit bubble to unwind, the banking sector may soon be in for a spot of "interesting times" again. The ECB's banking review by contrast hardly needs to be feared, as the standards will have been sufficiently watered down by the time it is actually implemented. However, a spike in NPLs in the developing countries at the heart of the crisis would certainly represent a problem. Add to that the potential for the euro area itself to suffer crisis conditions again as well provided that money supply growth continues to slow down (which appears inevitable at this point) and there could be a heap of trouble on the way.

Charts by: BigCharts, Deutsche Bank, Jefferies, StockCharts