The great Western bank deleveraging
IIF sounds alarm on Western bank retreat from emerging markets, as capital flows are forecast to fall to $746bn this year
Bank to the future for EM capital flows. Well, sort of. Net private capital flows to emerging markets will decline to total $746 billion this year, from $910 billion in 2011, according to the Institute of International Finance (IIF).
In a report published on Tuesday, the IIF made a striking observation: it estimated that net commercial bank flows to EM declined to $137 billion in 2011 from $162 billion dollars in the previous year. For 2012, it projected a sharp further fall in bank flows to a total of $38 billion. Yes, just $38 billion.
(On the upside, net inflows from non-bank private creditors i.e. FDI and equity inflows are set to fall by less, due to EMs secular growth story.)
The $38 billion estimate just triple Apples fourth-quarter 2011 profit throws into sharp relief the extent of the banking crisis. But just how much of a surprise is the mere fact that Western bank lending has been sharply reduced? On the face of it - if you believed the pro-EM utterances from Western bank executives in recent years the figure is startling.
Western banks are choking on excess liquidity, siting on paltry yields on government paper and have few solvent borrowers that want to leverage themselves in their home markets. At the same time, EM investment and consumption trends are in relative terms more buoyant, while their EM subsidiaries, by and large, offer asset quality and years of stable earnings that in theory provide a cushion for NPLs.
But forget about this sound business logic, for now. Capital preservation and balance sheet massaging are now key.
According to the IIF:
|As sovereign debt problems deteriorated within the Euro Area in the second half of 2011, banks in the region came under intense funding pressure, especially in international markets. These greater funding difficulties particularly in the dollar market led many Euro Area banks to begin to trim international assets aggressively, starting in 2011Q3. This deleveraging was accelerated by measures taken by the European Banking Authority (EBA) in an attempt to shore up Euro Area banks by forcing them achieve a 9% core Tier 1 capital ratio by the middle of 2012. In an environment where raising new capital was extremely expensive, Euro Area banks responded by accelerating asset shedding, especially in foreign markets.|
And its not just Eastern Europe that could be in the line of fire interbank lending to Asian banks is set to fall further, if the post-Lehman lesson is anything to go by, warned the IIF.
But herein lies an historic opportunity for Chinese banks, in the IIF's words:
|The withdrawal of European banks from Emerging Asia could, for example, open the way for Chinese banks to become more involved in the region. By way of illustration, three Chinese banks (China Development Bank, Export- Import Bank of China and Industrial and Commercial Bank of China) made a loan of $1.2 billion to Reliance Communications of India (7 year maturity, at 5%) in mid-January. The loan will be used to repay maturing foreign currency convertible bonds, which are not being converted to equity because of the fall in the stock market.|
More generally, here are some crumbs of comfort: as we have noted, this year, monetary stimulus is all the rage in emerging markets, and in Asia in particular. As a result, Western bank subsidiaries in EM should be able fund themselves in the domestic money markets at cheaper rates, as well as local deposits, rather than via cross- border borrowing.
The IIF's full report (paywall)