Threat of Contagion to Eurozone from Spanish Banks’ Huge Bet on Emerging Markets: UBS

Spanish banks expanded aggressively into Emerging Markets to flee the consequences of the euro debt crisis.

By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.

UBS has alerted that Spanish banks’ outsized exposure to Latin American markets could serve as a source of contagion for future crises: 80% of the Eurozone’s total banking exposure to the region is channeled through Spain whose banks have around €384 billion of counterparty claims in the region.

A ‘shock’ in emerging and developing markets could also drag down the Eurozone economy, UBS said. Spanish banks’ exposure to Latin America is equivalent to around 30% of Spain’s GDP and leaves both the country and the Eurozone susceptible to contagion effects from a crisis emerging in any of the major contingent economies, the authors of the report, Themis Themistocleous and Ricardo García, warn.

This is the second time this year that UBS has warned about the health of Spanish banks. In January the Basel-based lender made waves by slashing the price targets of all Spanish lenders citing two main concerns:

  • Spain’s slowing economic growth which, combined with the rising likelihood of never-ending zero interest rates in the Eurozone, could negatively impact the banks’ margins.
  • Spanish banks’ low capital ratios. Most Spanish banks, including giant Santander, have capital ratios below the minimum 12% level set by the ECB. What’s more, costly litigation continues to pose a big risk to Spain’s banking sector, including the pending sentence of the European Court of Justice on the legality of Spain’s IRPH mortgage reference index which, according to Goldman Sachs analysts, could alone cost Spanish lenders between €7 billion and €44 billion depending on the outcome. With such low capital ratios, it’s not clear how the sector will be able to absorb any significant negative impact, warns UBS.

Now, UBS has thrown into the mix the contagion risk posed by Spanish banks’ huge exposure to Latin America’s fragile economies. It’s not the only one who’s raised concerns about this risk.

At the end of 2017 the IMF warned in an assessment of Spain’s financial sector that the significant international presence of the country’s biggest banks, while providing welcome diversification effects, may also have significant implications for inward and outward spillovers:

The share of financial assets abroad has grown continuously for the Spanish banking sector, with the largest international exposures by financial assets concentrated in the United Kingdom, the United States, Brazil, Mexico, Turkey and Chile.

Most worrisome of all is Spain’s banking exposure to Latin America’s two mega-economies, Brazil and Mexico. In Brazil, Spanish banks had total exposure to the economy of $150 billion in the third quarter of 2018, down slightly from $161 billion in the first quarter, according to BIS data. It’s still the equivalent of 47% of total foreign banking investments in the country.

For Banco Santander, Brazil is by far its biggest market, accounting for 26% of its global operating profits, compared to just 17% for Spain. The Spanish too-big-to-fail lender also plans to expand its presence in Mexico by acquiring the remaining listed shares of its Mexican subsidiary, worth just over €2.5 billion. According to El País, the bank wants to take advantage of the high interest rates in Mexico, currently at 8% (compared to 0% in the Eurozone), as well as the galloping credit growth available in the market. In 2018 alone Santander Mexico increased its lending by 16%.

In Mexico Spanish banks already have over $160 billion invested in the economy, which represents 42% of total foreign banking exposure. This time it’s BBVA that is doing the heavy lifting, through its subsidiary BBVA Bancomer, the largest bank in Mexico. It provided 45% of BBVA’s group profits in 2018.

Across Latin America, from Argentina and Chile to Peru and Colombia, Spanish banks are far and away the most invested. In fact, it’s no overstatement to say that as goes Latin America so goeth Spain’s banking system. For the moment most of Latin America’s biggest economies, with the obvious exception of Argentina and Venezuela, are doing quite well. Crucially, both the Brazilian real and the Mexican peso are bearing up fairly well this year despite the rallying dollar.

But economic headwinds are brewing in both countries. In February, Brazilian economic activity contracted by the most in nine months prompting analysts to revisit earlier projections of 3% growth for this year. A similar thing is happening in Mexico where a sharp increase in violence and uncertainty over the future of the state-owned oil giant Pemex are taking a big toll on economic sentiment and activity. Both the IMF and the Bank of Mexico have slashed growth forecasts for this year from 2.1% to 1.6%.

But the most immediate emerging market risk for Spanish banks is half a world away, in Turkey, where a repeat of last year’s crisis could be in the making as a maelstrom of political, geostrategic, economic and financial pressures buffet the country. The unemployment rate reached a near-decade high this week while the lira slumped to a six-month low against the dollar.

Between the first and third quarters of 2018, as the last Turkish crisis roared, Spanish banks slashed their exposure to the Turkish economy by around a quarter, from €82 billion to €62 billion. But they’re still much more exposed than any other foreign banks and the risks in Turkey are not going away any time soon.

If things do kick off again on the Anatolian peninsula, the biggest risk for foreign banks operating there, such as Spain’s BBVA, Italy’s Unicredit, Holland’s ING and the UK’s HSBC, is that Turkish borrowers begin to default en masse on foreign currency loans, which account for a staggering 40% of the Turkish banking sector’s assets. And no bank is as exposed to such a risk as BBVA, which has already lost over 60% of its €6.9 billion investment in Turkey as a result of the plunging Lira and the plummeting shares of its Turkish subsidiary, Turkiye Garanti Bankasi AS. By Don Quijones.

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