Evaluating the potential impact of deleveraging by euro area banks on emerging market economies

12 December 2011

(Extract from pages 21-22 of BIS Quarterly Review, December 2011)

The latest financial developments in the euro area have given rise to concerns that, rather than raise new capital, euro area banks could deleverage by reducing their lending to emerging market economies. In this box, we use data from the BIS international banking statistics to quantify the degree to which various emerging market economies depend on banks headquartered in the euro area for foreign financing. In addition, we re-estimate the foreign bank credit withdrawal vulnerability measures discussed in Box 1 on pages 16-17 for a dataset encompassing exclusively euro area banks.

Not surprisingly, as of the end of June 2011, the fraction of total lending to non-banks attributable to euro area banking systems was highest in the neighbouring region of emerging Europe (Table A, first column). These banks accounted for approximately 42% of all credit to non-banks in the region. In addition, their claims on banks in that part of the world amounted to 5% of total credit to non-banks in the region. Euro area banks were also responsible for a significant share of total lending to non-banks in Latin America and the Caribbean (16%) and Africa and the Middle East (11%). By contrast, these banks were not nearly as important in Asia-Pacific, accounting for only 1% of all lending to non-banks in the region.

Estimates of the recapitalisation needs of various euro area banking systems released recently by the European Banking Authority indicate that the extent of the potential deleveraging is likely to vary significantly across banking systems. In order to account for that, we construct an index which measures emerging market economies' dependence on foreign bank lending that originates in euro area banking systems which will have to increase their capital ratios in the coming months (Table A, second column). For every emerging market economy, we calculate the index by weighting the lending share of each euro area banking system by its estimated capital shortfall scaled by its riskweighted assets.

Once the near-term recapitalisation needs of euro area banking systems are taken into account, the contrast between developing Europe and the other three emerging market regions becomes even starker. More precisely, the index, which has a value of 41.8 for emerging Europe, suggests that the credit dependence of that part of the world on euro area banking systems that are currently experiencing capital shortfalls is more than four times greater than that of Latin America and the Caribbean, which is the second most dependent region according to the index (9.6). The values of the index for Africa and the Middle East and Asia-Pacific are much lower (4.8 and 0.5, respectively).

There are several factors that may mitigate the potential impact of euro area banks' deleveraging on emerging Europe. First, only a third of all euro area banks' lending to the region is accounted for by cross-border claims (third column of Table A). The rest is in the form of locally booked claims, which, as discussed in Box 1, tend to be much more stable. Second, the share of euro area banks' claims on emerging Europe with a maturity of less than one year (33%) is significantly lower than the respective shares in the other three emerging market regions (fourth column). Finally, banks located in the euro area hold only about a tenth of their total international claims on emerging Europe in the form of tradable debt instruments (fifth column). As a result, it would be relatively difficult for them to quickly and costlessly dispose of most of their claims on the region.