Fitch Highlights EU Banks Exposed to Vulnerable Emerging Markets

A handful of large European Union (EU) banks are materially exposed to more fragile emerging markets (EM) known as the ‘Fragile 8’, according to Fitch Ratings.

While the credit ratings agency (CRA) believes these risks are manageable, they may be understated if there is contagion to other closely connected emerging and developed countries.

Fitch names Spain’s Banco Santander is most exposed to more fragile EMs in its review of large EU banks, through its significant presence in Brazil, Argentina and Chile. Its net exposure to these countries was equivalent to around 370% of Fitch Core Capital (FCC) at end-1H13, according to data from the European Banking Authority’s (EBA) transparency exercise and company financial statements. This is higher than for other European banks with EM franchises.

However, Santander is in a good position to absorb credit shocks from more fragile EM operations because it has geographically diversified and profitable retail franchises and a strong track record.

Brazil dominates Santander’s exposure to the so-called ‘Fragile 8’ (Brazil, India, Indonesia, Turkey, South Africa, Argentina, Russia and Chile). It contributed 23% to 2013 profits according to the group’s results presentation, and represented 275% of FCC at end-1H13. However, Fitch believes Santander’s majority-owned Brazilian subsidiary is in a relatively good position to face economic volatility and asset-quality pressures from rising interest rates. It has a broad national franchise, diversified revenue base, strong capital and comfortable liquidity.

Markets outside the ‘Fragile 8’ made up around 70% of Santander’s 2013 profits, spread among continental Europe, the UK, the US and other Latin American countries. Spain, which is in the initial stages of economic recovery, only contributed 7% to group profits (excluding Spanish run-off real estate).

Other European banks have more modest, but still material exposures to the ‘Fragile 8’. BBVA is exposed to Turkey through its 25% stake in Garanti Bank and has majority-owned subsidiaries in Chile and Argentina (114% if Garanti Bank is proportionately accounted).

Standard Chartered operates in India and Indonesia, with related cross-border risks of 111% of FCC. Barclays is exposed through its South African majority-owned subsidiary, Absa Bank Limited (103%). Unicredit has operations in Turkey and Russia (98%). The inherent EM volatility from these exposures is already factored into the CRA’s ratings through the analysis of the operating environment and company profile.

But risks may be understated as these numbers do not capture the interconnectedness of many countries to EMs, says Fitch. For example, HSBC only has exposures equivalent to 60% of FCC, relatively low considering its international footprint. These are well spread outside Brazil (38% of FCC). But its risks in Hong Kong from the territory’s close links with other EMs are not reflected. Risks may also be understated for similar reasons at Standard Chartered and some other European banks.

Investors’ reaction to the tightening of US monetary policy has particularly affected a group of EM countries with current account deficits. These were originally known as the ‘Fragile 5’ – India, Indonesia, Brazil, Turkey and South Africa, but have since been joined by Argentina, Russia and Chile to make the ‘Fragile 8’.

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