Asian Borrowers on Guard Over European Crisis

James Lamont and Henny Sender

Who catches a cold when Europe sneezes?

The European debt crisis, which has pummeled global markets and is taking a heavy toll on its banks, is threatening to spill over into the Asian banking sector as the region’s lenders calculate their own exposure to the crisis — direct or otherwise.

Keith Brofsky | Photodisc | Getty Images

Asian banks’ direct exposure to troubled European banks, bonds and economies is relatively small, with Japanese groups’ holdings of bonds dwarfed by their Japanese government bond holdings. Meanwhile, Chinese banks largely conduct all their business in the domestic market and so have very little exposure.

However, it is the knock-on effects that are troubling analysts, banks and other companies in Asia, as European lenders retrench and shrink their balance sheets, sucking capital out of the region. This is raising funding costs for many smaller banks.

Jykri Koskelo, special adviser to the chief executive of International Finance Corporation, the private sector financing arm of the World Bank, says this is happening to the detriment of emerging markets. “The question that is critical for all of us is that, if this is what is going to happen to the Organisation for Economic Co-operation and Development banks, what will be the impact on India, China and Brazil?”

Taiwanese banks, for example, have started to trigger “market disruption clauses” on syndicated loans to Asian companies, which allows banks to increase the rate at which they lend to a company if their own funding costs rise significantly higher than benchmark rates.

In India, companies are already wrestling with rising domestic borrowing costs, and so the retreat of financing by European banks for their ambitious expansion projects means they face a capital crunch.

Some of India’s largest borrowers are big power and infrastructure companies, including Tata Motors, Reliance Industries, Jaiprakash Associates, an infrastructure company, and Bharti Airtel, the telecommunications group.

Domestic interest rates are high after 13 successive rises in the benchmark lending rates by the central bank. Foreign capital is retreating to the core in Europe and the U.S., restricting the ability of Indian companies to raise capital through loans or bonds.

Stretched local banks, meanwhile, are undercapitalized and unable to extend the finance necessary to sustain fast-paced economic growth, according to a senior Mumbai-based banker.

“The government will need to keep infusing capital in state banks to support their loan growth,” says Mahrukh Adajania, an analyst at Standard Chartered Bank. State banks have to look to the government for capital support because the government stake in state banks needs to be maintained at 51 percent and in many banks it is close to the threshold.

He forecasts that stressed assets for Indian banks, such as the State Bank of India and Punjab National Bank, would rise over the coming two years as a result of higher borrowing costs and lack of clarity on government policy.

Some Indian companies are already visibly weighing heavily on their state-owned creditors’ balance sheets. These include Kingfisher, the airline owned by Vijay Mallya, Shree Renuka Sugars and GTL Infra.

So far analysts at GaveKal believe the system has not come under too much strain. For one thing central bank reserves in most Asian economies have not fallen much, a sign that the central banks have not had to step in to provide dollar liquidity.

Also, large banks in Asia that do not have significant direct exposure to the eurozone crisis could help fill the gap left by departing, cash-strapped European banks.

Japanese lenders, for example, have little loan growth at home and are focusing on expansion in the rest of Asia, rather than buying up distressed assets in Europe.

Meanwhile, Australian banks are also healthy.

Australian deposit-taking banks had tier one capital ratios of 10 per cent at the end of June, up from 7-8 per cent before the financial crisis, according to John Laker, chairman of the country’s banking regulator, in a recent testimony to the Australian senate.

The introduction into Australia last week of covered bonds, debt backed by assets kept on banks’ balance sheets, gives the banks additional options for raising debt even from risk-averse investors.

Some analysts concur with the view that the situation may not be that dire. For example, Jonathan Anderson, an economist with UBS in Hong Kong, notes that Asian economies are “essentially self-sufficient in terms of finance for local investment, consumption and working capital”.

The flows from European banks are primarily connected with trade finance, he says. That means that, even if the European banks pull back, as seems to be happening, either global banks, such as HSBC, or local banks can pick up the slack, in part because such finance does not require banks to set aside much precious capital against such lending.

Still, Mr Anderson concedes all this is dependent on banks maintaining lines to each other, since it is in their interest to maintain a stable interbank market. In fact, banks are all wrestling with the dilemma that it can be prudent to cut lines to counterparties whose funding base is fragile, yet if everyone cuts those lines, everyone is worse off.

Additional reporting by Sarah Mishkin