Taken from the Far Eastern Economic Review
No Pain, No Gain
European banks brace for Asian fallout--but sit tight
By Shada Islam in Brussels
February 09, 1998
Y ves-Thibault de Silguy is keeping close tabs on Asia's financial crisis.
So far, says the European Union's Monetary Affairs Commissioner, it's not
so bad: Europe may even escape the Asian crisis relatively unscathed, he
predicts.
EU trade with Asia represents only 2.3% of the bloc's GDP. That's why de
Silguy isn't worried about a decline in European sales to the region. A
fall-off wouldn't make much of a dent in the EU's projected 3% growth rate
for 1998, nor would it derail EU plans for launching the euro--the single
European currency--on January 1, 1999.
But even the upbeat EU commissioner admits that there could be a chink in
Europe's armour: Its banks are more vulnerable to the storms battering
Asia's financial markets than initially anticipated. The Bank for
International Settlements in Basel released data showing that by June last
year, European banks held $365 billion in loans outstanding to Asian
companies and banks--way ahead of the $275 billion and $45 billion in
exposure notched up by Japanese and American financial institutions
respectively.
When the going was good, the Asian connection brought profits and
prestige to Europe's financial institutions. Now that the tide has turned,
European banks are going to feel the pain. But even though they are
setting aside hundreds of millions of dollars to cover potential bad loans,
many European bankers insist they are not going to abandon Asia. On the
contrary, some are on the acquisition trail.
Still, preliminary estimates of the damage are grim: The international credit
agency Standard & Poor's, for example, has warned that European banks
could face losses of up to $20 billion on their Asian loans. It expects 30%
of European bank loans to Thailand and 50% of loans to Indonesia to be
nonperforming in 1998. Adding to the gloom, Moody's Investor Services
says that given their large exposure to troubled markets in Asia, it may
downgrade the credit ratings of 10 European banks. Among them: France's
Credit Lyonnais and Germany's Commerzbank.
"Everyone underestimated the extent of European banks' exposure in
Asia," says Robert McKee, chief economist at Independent Strategy, a
London-based consultancy. But the reality is harsh, he says. French bank
loans to Asia are equivalent to 2.5% of France's GDP; the ratio is 2.3% in
Britain and 1.8% in Germany. Belgium is even worse off, with an exposure
equal to 4% of its GDP.
"The Asian crisis is going to hit European bank profits and earnings,"
McKee warns. This could have negative trickle-down effects on Europe's
economic growth and general prosperity. "Banks in Europe aren't going to
go bankrupt because of Asia," he predicts. "But Europe's links with Asia
are more complicated than if you look at just EU-Asia trade."
European banks say they are prepared for the pain. While most
acknowledge that Asia's problems will affect profits, they say they're
strong enough to cope. Despite high exposure to Asia, operations in the
region account for less than 10% of most banks' earnings. And more than
half of European banks' Asian loans are to banks and companies in Hong
Kong and Singapore. "Both are known for their relatively disciplined
financial institutions," says an aide to commissioner de Silguy. "Their
economies have also been the least affected by the crisis in Asia."
Helped by a two-year upturn in the EU economies, European banks are
also "enjoying exceptional profitability," says Philip Crate, head of credit
research at Paribas Bank in London. As such, most are able to respond to
the Asian difficulties from a position of strength. "European bank exposure
in Asia is containable in relation to their core earnings and capital," Crate
stresses. While individual banks may face a downgrade in their credit
ratings, the overall profitability of European banking groups is sufficient to
cover increased levels of loan-loss provisioning.
Deutsche Bank is a case in point. With a total exposure of 9 billion
Deutsche Marks ($4.9 billion) in Asia, Germany's largest bank announced
on January 28 that it was setting aside 1.4 billion marks to cover possible
losses in lending to the region's troubled economies. The move wasn't
painless: It more than doubled the bank's total provisions for 1997 and
reduced the year's earnings by one-third.
But Deutsche Bank spokesman Detlev Rahmsdorf insists there's no cause
for alarm. "We're taking a precautionary step," he argues. "We're not
saying that there will be losses on our Asian loans. Most of our clients are
top class and will pay back. But we do not know if they will repay 100% of
the loans. And we want to be prepared if there are problems."
It's the kind of thinking that satisfies investors. When Deutsche Bank
announced its plans--which included a wide-ranging reorganization of the
bank--its share price initially tumbled. But it soon shot up 8.55 marks, or
7.8%, to 118.65 marks. "Markets like a bank which acts in a transparent
manner," says one banking specialist. "And they can penalize those which
take a long time to recognize their problems."
That probably explains why Deutsche Bank isn't the only European lender
that's going public with measures for covering possible Asian loan losses.
"It is not possible to predict the length and impact of the Asian financial
crisis," says Commerzbank Chairman Martin Kohlhaussen. But just to be
on the safe side, Commerzbank is earmarking 1 billion marks to offset its
Asian risks. The Bavarian state-owned bank, Bayerische Landesbank, also
made provisions of 500 million marks in 1997 for Asia.
In France, Societe Generale is taking a provision of $162 million for its
estimated $6.8 billion exposure to Asia, and says it could add to it in the
coming months. And Credit Lyonnais, with $9 billion in loans outstanding
to Asia, excluding Japan, says it can also "make any provision necessary
to cover additional risks."
European banks acknowledge the need to be more selective in future Asian
lending operations, but there's no talk of pulling out of the region.
"Banking is a risky business," stresses Commerzbank spokesman Peter
Pietsch. "If you want to make profits, you have to take risks. It would be
too short-sighted to retreat from Asia."
This is partly because Europe's competitive banking environment puts
pressure on banks to seek out foreign pastures to survive and flourish.
While there will be few new opportunities to fund vast infrastructure
projects in Asia for the foreseeable future, this is the right time for
forward-thinking European banks to pick up cheap assets in Asia, says
Paribas' Crate. "Banks could be buying up business franchises in Asia at
knock-down prices," he stresses.
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