IN NOVEMBER, A presentation appeared on Latvian bank Parex’s website entitled ‘The leading independent bank in the Baltics’. Its timing was unfortunate.
Just days later, on November 7, the bank applied for support from the government following a run in which 12% of total deposits had been withdrawn since October 1. Latvia’s government acted immediately. The following day it announced that Parex, the Baltic republic’s second-biggest bank, had been nationalized after state-owned Mortgage and Land Bank acquired 51% of its shares. In addition, the government provided a liquidity injection and a guarantee for €775 million of syndicated loans that are coming due next year.
Even with these moves the bank’s future looks precarious. Resident and non-resident deposit outflows continue, according to Fitch Ratings, and the chairman of Mortgage and Land Bank has suggested that the government needs to inject at least a further Lats200 million ($355 million) of funds. Sixteen years after it opened its first commercial branch, Parex is on a life-support machine.
Decoupling debunked
The Parex crisis is not a parochial event. It is, so far, the highest-profile emerging markets banking casualty of a financial crisis that is spreading fast to all developing regions. Its story of deposit outflows, refinancing woes and government support and consolidation will become a familiar one for several banks in the emerging markets, if it is not already.
For so long, these banks appeared to have escaped the worst of the credit crunch. Yes, some in Kazakhstan and, to a lesser extent, in Russia were caught up in the financial storm that was brewing in the US and Europe. But until recently, most financial institutions in central and eastern Europe, Latin America, Asia and the Middle East seemed to be in decent shape. Unlike their western counterparts they had not, for the most part, made investments in sub-prime mortgages.
Only a handful of banks, such as Bank of China and Abu Dhabi Commercial Bank, had sizeable exposures and these were largely manageable. Of the reported $580 billion of write-downs made by banks by the end of September, less than 5% can be attributed to institutions in the emerging markets, according to the IMF’s Global financial stability report.
Yet while most banks in the emerging markets steered clear of toxic sub-prime investments, it was always wishful thinking that they would avoid the western world’s pain. The decoupling theory has been well and truly debunked and with the global economy heading for recession, life is going to get much tougher for banks in emerging markets as a new wave of credit problems gathers pace.
"The world went on a borrowing binge – and not just in the US or Europe," says Walter Molano, head of research at BCP Securities in Greenwich.
While credit growth in emerging markets varies from country to country, some, such as Russia, Kazakhstan, Ukraine, Korea, India, UAE, Chile and Brazil, experienced big increases. In Russia, for example, year-on-year real private-sector credit growth jumped from 17.7% in 2005 to 32.1% last year, according to HSBC, while in Brazil it went from 10.5% to 26.6% over the same period.
As economies around the world slow, not only will credit growth slacken substantially. In many countries, banks will face a growing non-performing loans problem as unemployment and corporate defaults pick up. The underlying assets might not be mortgages but rather other forms of consumer credit.
"In Brazil, for example, a friend of mine says that their sub-prime problem is not real estate but automobiles," says Molano. "In Chile, it’s retail consumer loans."
As in the west, lax lending practices could come back to haunt the banks. In many emerging markets, for example, borrowers take out auto loans against expected rather than realized income by including their overtime hours in their contracts. Those overtime hours could well dry up if economic growth wilts, leaving borrowers struggling to repay.
What is especially worrying, adds Molano, is that there is a denial across the emerging markets about the extent of the overall problem. "People don’t get how deep and severe this crisis is and how exposed they are," he says.
For many emerging markets banks the full consequences of their actions over the past few years have yet to filter through. "I don’t think they’ve gone through much pain yet," says Molano. "We’ve seen the pain in terms of financial asset prices but we haven’t seen the big increases in NPLs yet."
In Russia, stories are emerging of how some corporates, in the construction industry for instance, are struggling to pay their suppliers because they cannot gain access to short-term funding from banks. Although it is difficult to quantify how great a risk this is, as reporting is often delayed, the inability of corporates to manage their cashflows will ultimately lead to their businesses being put in jeopardy, which in turn will have a serious knock-on effect on banks’ balance sheets.
"We’re in the initial stages and the problem will run for another year, though it depends on external conditions," says Molano.
He is at least less bearish about the global outlook, following the capital injections, bank guarantees and liquidity support provided by various governments over the past few months. Emerging markets banks, though, will still have to go through the readjustment process and cut back their lending and increase their provisioning levels.
Rollover risk
At the same time, banks face severe pressure over their ability to refinance their existing stock of borrowing and to raise new funding.
ING Wholesale Banking reckons that emerging markets have a $111 billion backlog of bonds that need to be refinanced between the last quarter of this year and the end of 2009. Financial groups and banks, which accumulated large amounts of debt before the credit crisis, account for $59 billion of that total and in the fourth quarter of next year will face redemptions that are twice the average level of the previous two years.