Can European banks’ problems affect Latin America?

European banks provide 45% of all the external credit lines to Latin America. Could a pull back from their international lending activities affect the operations of Latam companies?

According to the Bank of International Settlements (BIS), European banks provide USD 206bn in credit lines to Latin America, making them the biggest providers of external funding for the region. Continued pressure from the financial crisis in Europe raises questions about the extent to which these banks will need to restrain or even reduce their global lending activities. One can assume that it will take time before European banks regain their ability and willingness to extend international credit at the pace they have during the last decade. Most of the international claims reported by the BIS are trade-finance related and inherently short term.

For the region as a whole, the impact of such a potential deleveraging does not appear to be significant. However, some countries would be more vulnerable, namely Chile and Uruguay where European banks provide 63 and 57% of total funding respectively.

We look at a few factors that can be used to measure the impact of a shift in European bank lending on Latin America.

1- How fast can the current credit lines disappear?

Looking at the maturity of these loans can give us an idea of how quickly European banks could restrain credit. Hence, data show that a significant amount of credit lines to Latam corporates need to be renewed in the next 12 months and apparently a majority are not being renewed. Short term maturities of less than one year account for 40% of international bank claims in Brazil and Mexico (Table 1). In the case of smaller economies like Uruguay and Colombia, that number is over 50%.

Table 1. International claims by European banks, less than one year maturity

% of total claims

Argentina 60
Brazil 40
Chile 49
Colombia 61
Mexico 41
Peru 57
Uruguay 58
Venezuela 33

Source: BIS, HSBC

2- What is the reliance of the region’s economies on credit lines?

We use the ratio of European banks claims on foreign exchange reserves. Here the data show that Mexico, Chile and Uruguay are quite dependent on European banks’ funding while Brazil, due to its high level of foreign reserves, is in a comfortable position. For Argentina and Peru, exposure to European banks funding is fairly low. In their case, this is the result of the limited access these two countries have had to international financing over the past few years.

3- Are there alternative sources of financing to fill the gap left by European banks?

The sheer size of the involvement of European banks in Latin America suggests that funding may turn scarce for a while and result in higher borrowing costs for exporters. There are already signs of retrenchment by some European banks in Brazil. Banco Santander, Spain’s largest bank by market capitalization, which underwrote 11% of Brazilian debt sale in 2011, is currently not working on any large size underwriting deal.

Inevitably Asian banks will eventually step in but probably only gradually. Asian banks for the most part are very well capitalized-- in fact exceeding Basel III requirements-- quite experienced in trade finance and looking to expand globally. The three Japanese mega banks-- MUFG, SMFG and Mizuho-- in particular and a handful of Chinese banks could well become the next major funding partners for Latam exporters. In the case of Mexico, the close association with its northern neighbor could possibly bring American banks to play a larger role in that country.

Regional development banks such as the Inter-American Development Bank (IADB) and Corporacion Andina de Fomento (CAF) could also provide USD credit lines. BNDES in Brazil, a large development bank, will most likely be able to maintain access to capital markets even  during a period of stress and supply exporters with reasonably priced credit lines. Other possible sources of USD liquidity are the central banks. In Chile, in 2008, the central bank provided liquidity through a program of swaps and repos to the country’s financial system. Given the size of its foreign exchange reserves—USD350 bn-- Central Bank of Brazil could auction a small amount of its international reserves to its domestic exporters.

4- What is the ability of Latam exporters to absorb potential higher costs associated to a reduction of European banks lending activities?

Industrial exporters are likely to be more affected than commodity-related exporters due to the real appreciation of some currencies in the region during the past decade. The Brazilian Real has nearly doubled in value, in inflation-adjusted terms, since 2000. During the same period the Chilean Peso, the Colombian Peso and the New Sol in Peru have all appreciated between 18 and 26% in real terms. Commodity-related exporters have a better protection against higher funding costs because terms of trade in the region in general remain historically high. That is, export prices have risen faster than import prices so higher funding costs are unlikely to erode export competitiveness and profitability.

5- Can the size of local subsidiaries of European banks become destabilizing?

Local subsidiaries of European banks in the region act like local banks due to their size. Their deposit base is domestic and in local currencies. Three of the five largest banks in Mexico and Argentina are subsidiaries of European banks as well as two out of the five largest in Brazil. In Chile, Banco Santander of Spain is the largest bank by far. However, local subsidiaries are generally independent of their headquarters when it comes to making decisions on funding activities. There is obviously a risk that local subsidiaries receive ‘orders’ from Europe to become more conservative in their lending decisions. That seems far fetch as the opposite is most likely: grow more aggressively overseas to compensate for a slowdown at home.

Since Latam as a whole is expected to experience GDP growth of around 3.5% in 2012, local subsidiaries of European banks are unlikely to suddenly stop credit expansion. Moreover, it is worth remembering that many of these local subsidiaries are listed on domestic stock markets, hence owing part of their capital base to local investors.

Conclusion

The risks to Latam exporters arising from a reduction of European banks funding appear manageable. USD-denominated funding costs will likely increase during the first half of 2012. Industrial goods exporters, having suffered from a decade of appreciating currencies, are more vulnerable than commodity-related exporters. The latter will fare better because raw material prices remain high by historical standards, making the sector very competitive.

Chile and Uruguay appear most vulnerable due to their substantial reliance on funding from European banks. At the other end of the spectrum are Argentina and Venezuela, which have very little dependency on foreign funding. Brazil, Mexico and Colombia are in the middle.