Big borrowing emerging economies came into crisis with funding risks

A number of big-borrowing developing countries came into the coronavirus crisis with vulnerabilities due to their economies' reliance on foreign bank short-term funding, a Bank for International Settlements analysis has shown.

The severe global recession being caused by the impact of COVID-19 is expected to decimate millions of companies, but less developed economies would be particularly badly hurt if international banks rein in lending - or worse, beat a retreat.

During the 2007-09 financial crisis, growth in global cross-border 'claims' - a proxy for loans and other forms of credit - dropped from 22% year-on-year in 2007 to –10% in 2009.

Asia, where China is by far the biggest emerging market, saw a sharp –25% contraction, while in Latin America and emerging Europe it was still painful at around -15%.

The latest global banking data only goes up until the end of last year. That means it does not yet show the COVID-19 impact - but it does highlight vulnerabilities countries had entering the crisis.

Across all emerging economies, total short-term claims - credit with one year or less to run that tends to be most problematic during crises - amounted to $1.8 trillion.

That was roughly half of all 'international' claims, defined as cross-border lending and loans booked by local subsidiary banks but in non-local currencies.

International claims were the majority of banks' total foreign claims on emerging Asia-Pacific, at 64%, with the share as high as 75% for China.

By contrast, the short-term share of international claims on Poland, Russia, and Turkey were all below 50%, although in Turkey international claims did account for an outsized 66% of all foreign claims.

"The short-term share of foreign banks' claims, a key indicator of external vulnerability, is elevated for a number of borrowing emerging market and developing economies," the BIS said.

During the financial crisis, the rate at which foreign lending in individual emerging economies contracted varied.

For countries that relied on short-term cross-border credit, particularly interbank credit, the rate of contraction was fairly rapid as it could not always be rolled over and is often backed by short-term wholesale funding which had evaporated.

By contrast, banks' claims extended locally by affiliates located in the borrower country, and particularly those denominated in the local currency and backed by local currency funding, were more stable.

The Other Side

The study also pointed to other likely strains such as struggling companies now drawing down on credit lines and increasing the amount of emerging market credit in the system.

For most borrower countries, the BIS estimated that unused credit was in the order of 10−15% of their outstanding stock of claims, although in some it was likely to be larger.

Borrowers in Mexico had around an additional $70 billion of unused credit lines at their disposal, which works out at 19% of its total stock of claims.

The analysis also looked at which countries' banks were providing the money. Those whose banks were providing the bulk of their foreign credit as international claims and for the shorter-term "arguably have greater scope to scale back," the BIS said.

Claims on emerging economies account for more than half of Austrian banks' total foreign claims and roughly a third of Spanish banks' total foreign claims. Austrian banks lend heavily in Eastern Europe, while Spain's banks focus on Latin America.

Spanish banks book more than 70% of their total foreign claims locally in the borrower country and in that country's local currency. Austrian banks also had relatively high shares of locally-booked claims.

By contrast, French, Japanese, British and US banks, all with total foreign claims in emerging markets in excess of $450 billion, booked close to or less than 50% of their positions in the borrower country.

More than 80% of U.S banks' claims and about 60% of British banks' claims on EMs were also short-term in duration.

"There could be substantial heterogeneity among national banking systems in their reactions to the global financial shock triggered by the pandemic," the BIS said.