Credit squeeze in Asia now worst since financial crisis

Frederic Brown | AFP | Getty Images

Bank lending conditions in emerging Asian nations have tightened the most since the global financial crisis, according to the latest survey from the Institute of International Finance (IIF).

The IIF's index of bank lending conditions in emerging Asia fell in the second quarter to 45.7, below the key 50-level that divides easing and tightening territory and its lowest level since the beginning of the survey in 2009.

Asia also showed the tightest lending conditions of global emerging regions.

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The survey questioned 133 banks across Latin America, Europe, Asia and the Middle East- Africa region and Asia's headline figure of 45.7 was the lowest. Latin America was second-worst at 47.6 while Africa and the Middle East had the best result at 52.9.

The report cites three principal factors for Asia's strained credit conditions: deteriorating domestic funding conditions, high non-performing loans as well as declining loan demand.

The region's local funding conditions index dropped to 45.2, its lowest level since 2011 and the worst out of its surveyed peers. The report highlights that around 38 percent of Asia's surveyed banks reported a tightening in funding conditions compared to just 15 percent in the first-quarter of this year.

Asia also logged the highest pace of non-performing loans (NPLs) of the entire survey. The index reading for NPLs fell to 44, compared to the global average of 48.1. A figure below 50 implies a rising amount of NPLs.

Meanwhile, loan demand decreased for the second straight quarter with commercial real estate and consumer loan demand dropping for the first time since 2011.

India and China to blame

Frederic Neumann, co-head of Asian economic research and managing director at HSBC attributes the tight funding conditions to the on-going credit crunch in regional heavyweights China and India.

Chinese interest rates in the inter-bank market spiked to record highs in June, leading to a liquidity squeeze among local lenders, as the People's Bank of China deliberately refrained from cash injections in a bid to curb excessive credit growth.

(Read more: China to keep credit growth steady: Central bank)

But recent spikes in interbank rates suggest that volatility has not yet eased. China's seven-day benchmark repurchase rate rose to 5 percent on Monday, following a jump to 4 percent on Friday - well above average levels of around 3 percent.

In the past week, India's central bank has also engineered liquidity tightening in a move to stabilize the plummeting rupee. The measures include forcing banks to maintain 99 percent of their daily cash reserve ratio requirement.

(Read more: India's drive to boost investment just isn't working)

"One reason why the recent spike in short-term rates in both China and India may have a more damaging effect than earlier jitters in financial markets is that it comes at a time when economic activity is already slowing rapidly. This in itself amplifies risk aversion and tightens financial conditions well beyond what can be inferred simply by looking at benchmark interest rates," said Neumann in a report.

Financial markets may have calmed down since the start of July but analysts widely agree that more evidence of liquidity in the greater economy is needed in order for growth to rebound in the coming quarters.

— By CNBC.com's Nyshka Chandran. Follow her on Twitter @NyshkaCNBC