How much exposure the European banks hold to LatAm countries? First let’s start with a couple of figures below … after all, a picture paints a thousand words.
Spanish banks hold the largest presence in the region, and Spain is the most-involved country in the trade finance business. Chile is the most exposed to European banks (34% GDP), and the presence of Spanish banks is dominant. But the region is significantly less exposed than EEMEA and EM Asia, where European banks hold, on average, an exposure of 62% and 30%, respectively (14.5% in LatAm). Clearly, a problem with the Spanish banking system could amplify the liquidity crunch in the region, especially in Chile.
Anecdotal evidence of what is happening in the Brazilian markets could help explain how an orderly deleveraging process could unfold in LatAm. There are growing concerns that European banks have been decreasing their supply of cross-border lending to Brazil. Contracts have decreased in duration and the cost has risen. But, at the same time that the largest European banks have been moderating supply, there have been signs that other financial institutions outside of Europe are taking the opportunity to increase exposure and absorb some of this business. So, the aggregate level of supply of trade finance lines may be declining at a softer pace than if all banks were stepping out.
Spain’s banks were exposed to a property boom that went bust in 2008, forcing them to make provisions of billions of euros for bad loans to developers, which has eroded their capital and profits and restricted lending. Meanwhile, unemployment in Spain shot up to 22 percent and the economy is heading into its second recession in three years. The Bank of Spain recently estimated the sector had about 176 billion euros worth of doubtful property assets. Bad loans as a percentage of the total is running at more than 7 percent, the highest rate since 1994.
The real issue threatening Spanish banks is exposure to domestic real estate. No European Union summit has tackled this and the current government has not had a real plan to tackle this either.
One of the first things the likely new government will do is force banks to mark property assets to market price and then recapitalise the banks that are left with a big hole, possibly with money from the European financial rescue fund.
But economists question how property on banks’ books can be re-valued since the real estate market is largely frozen. “If the banks were to write down their property holdings today the whole financial system would go bankrupt… We can’t risk that,” said Juan Jose Toribio, economics professor at the IESE business school in Madrid. “Cleaning up the system is very difficult at the moment. There has to be some sort of mid-way solution between writing down property assets, which would require a massive recapitalisation effort, and allowing them to fester on banks books,” he said.
One alternative gaining more ground with bankers is the creation of a bad bank to manage all the toxic assets.
The question is how to do it … it remains to be seen.
Source: Reuters, Barclays