‘Substantial’ credit crunch looms over Asia

Asia looks set to be hit by a withdrawal of funding by European institutions grappling with the eurozone debt crisis, ADB president Haruhiko Kuroda has warned.

In an exclusive interview with Emerging Markets he said that anecdotal evidence indicated that European banks had already withdrawn a “substantial amount” of loans from Asia.

His comments in Manila came as the International Monetary Fund and ratings agency Standard & Poor’s both warned of the negative impact of so-called deleveraging by European banks.

Kuroda said that a number of countries had been affected by withdrawal of financing. Asia could be subject to continued withdrawal of European credit in coming months, he added.

“The worst phase [of the eurozone crisis] may be over but there are still fundamental problems. The banking sector in a few European countries continues to suffer from non-performing assets and forced deleveraging. It still requires careful monitoring and if necessary a strengthening of capital.”

Kuroda noted that Asian countries with “relatively open economies and open capital accounts” have been most affected, citing some in ASEAN and South Korea.

IMF deputy managing director Naoyuki Shinohara told Emerging Markets yesterday that the situation in the eurozone was “still fragile”. European authorities needed to make further efforts to regain the confidence of the market, he said. Deleveraging of risk by European banks was an “ongoing process and likely to continue for a few years to come”, he warned. “Deleveraging is already impacting business and economic activity in Europe and could affect Asia in similar ways,” he said.

Standard & Poor’s echoed that, warning that a renewed outbreak of crisis in the eurozone would affect companies in the Asia-Pacific region because of stresses in the European banking sector.

The ratings agency has put a 40% probability of a severe recession in the eurozone, and warned of a “material risk” of reduced appetite for lending to Asia by European banks.

A withdrawal of European bank capital would negatively impact foreign currency lending in the trade finance, derivatives and syndicated loan markets, reducing credit supply, Ritesh Maheshwari, S&P financial services analyst, told Emerging Markets.

European banks have the largest presence among foreign lenders in the Asia-Pacific region with $841 billion total exposure, as of December 2011, according to Bank for International Settlements.

Between June and September 2011, European banks’ total exposure in Asia-Pacific declined 10.1%, driven by higher funding costs, tighter liquidity, and more stringent credit standards.

However Kuroda observed that since the end of last year financial markets had become much more stable, owing to very substantial liquidity provision made by the European Central Bank and the “very successful reduction” of Greek debt.

But in some countries “a fiscal problem exists and fiscal consolidation was absolutely necessary in peripheral European countries,” he said.

Shinohara agreed that the situation had stabilized, adding: “We are witnessing some signs of recovery but in a very gradual way.”

Kuroda said that Asian financial systems were “stronger and more robust” now than they were when facing crises in the past, and that, despite recent slowdowns in their economies China and India would maintain strong growth that will continue to power the rest of Asia.

However he played down hopes that US and Japanese banks would fill the gap left in Asian and other emerging markets by the withdrawal of European banks.

But Gerard Lyons, group head of global research at Standard Chartered, said that while continental European banks had cut their exposure to Asia, the impact should not be “overstated”.

“I would expect to see a significant substitution effect – with other banks, whether international banks like Standard Chartered, or local and regional Asian banks picking up the business,” he told Emerging Markets.