Europe's Asia connection

To shore up Tier-I capital, European banks may exit more Asian assets, putting further pressure on currencies in the region.

Commodity prices have corrected, the Reserve Bank of India’s tone has turned dovish and the rupee has stopped falling. All these may sound like positive signs, but some ripples from Europe are still to touch Indian shores. With the euro zone has committed to a war chest of euro 106 billion for the recapitalisation of banks and to provide bank guarantees for liabilities, it’s certain that European banks will do their bit to shore up Tier-I capital.

To do so, these banks may need to reduce their assets. Economists believe these banks may reduce their foreign risk, especially in Asia. Contrary to what most may believe, European banks have substantially increased their exposure to Asia after the 2008 crisis.

According to Deutsche Bank, cross-border lending to Asia has surged since late 2009, passing the pre-global financial crisis’ stock of claims in the third quarter of 2010. By June this year, the stock of international bank cross-border claims on Asia was $2.2 trillion, about 32 per cent higher than in mid-2008. Excluding Hong Kong and Singapore (to minimise double counting, as a lot of money gets routed through these centres), the total stock of claims was $1.2 trillion, about 40 per cent higher than the pre-crisis levels.

The net claims of these international banks amount to 14.3 per cent of foreign currency reserves of the region (Asian economies). Though Malaysia, Thailand, Taiwan and South Korea have a much higher ratio of international bank claims to GDP, India is not immune to the risk of capital withdrawal.

According to Peter Hooper of Deutsche Bank: “We do not know whether European banks’ share of short-term claims is greater or smaller than their share of total claims. If we assume the shares are the same, then Vietnam, South Korea, Indonesia and India seem more vulnerable to a withdrawal by international banks, in the sense that there may be relatively greater pressure on their currencies from such a withdrawal.”