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Foreign Exchange

BIS confirms EU bank deleveraging; EEMEA currencies still at risk

Figures from the Bank for International Settlements confirmed that EU bank deleveraging from emerging markets, a key support for the euro, continued in the fourth quarter of last year.

Data showed Eastern Europe, the Middle East and Africa (EEMA) bore the brunt of EU banks’ retreat from emerging markets, often cited as one of the main reasons why the euro remained so resilient in the face of the eurozone debt crisis. In EEMEA, the non-weighted average of EU bank claims as a percentage of each country’s GDP dropped to 46% in the fourth quarter, from 50% in the third quarter and 55% in the second three months of the year.

There was less of a move in non-Japan Asia (NJA) and Latin America. In NJA, EU banks’ claims fell to 28% in the fourth quarter from 30% in the third quarter, while claims on Latin America were broadly unchanged at 14%.

 Non-weighted average EU bank claims - % of GDP

 Source: BIS, Barclays

  The move is unsurprising, given that it largely captures the period before the European Central Bank’s long-term refinancing operation (LTRO) on December 8 and was during a period of acute stress in the funding markets.

While that deleveraging is likely to have moderated in 2012, Sebastián Brown, strategist at Barclays, says there remains a clear risk that EU banks continue to pull funding from emerging markets.

Indeed, he says while wholesale funding market pressures are currently less acute than in the second half of last year, the deleveraging process is not over.

He says that is because, first, LTRO funding will need to be repaid, and unless banks are confident that wholesale markets will be completely open to them in three years, there is reason to reduce exposure.

Second, says Brown, in some of the EM destination markets – central Europe, for example – EU banks are likely to face a long period of sluggish growth as fiscal policy is kept tight and weak exports act as a drag on demand.

“A pick-up in capital outflows is likely if EU banks are unable to dispose of their assets during periods of stressed global risk appetite, which, in turn, could put pressure on asset prices, including currencies, in current account deficit countries,” he says.

“EEMEA economies, which are particularly large recipients of EU bank lending, are most vulnerable.”

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