UK banks have $878.2bn in claims on developing markets, making them vulnerable to a downturn. 

Emerging markets are in imminent danger of going into recession, the International Monetary Fund warned on the eve of its annual meetings earlier this month.

According to the semi-annual report, spiralling debt in the developing world could be rendered unsustainable by the combination of slowdown in China, plunging commodity prices and falling exchange rates, leaving lenders exposed.

The warning comes as many banks are already heading for the exits. According to figures from the Bank for International Settlements, of the 10 developed countries with the highest emerging markets exposure, eight have reduced their claims on the developing world over the past year. The only increases came from US and Japan, both of which increased their stakes in the Asia-Pacific region.

The UK has the largest exposure in absolute terms. UK banks have $878.2bn in claims on the developing markets (see chart one). The majority of that debt is in the Asia-Pacific region, where their stake is nearly 56.4% of total claims (see chart two). 

Total claims on developing countries, Q1 2015
Claims on developing countries by region Q1 2015

In particular, Asian operations drive revenue for two major British banks, HSBC and Standard Chartered. In the second quarter of this year almost 41% of HSBC’s net operating income was generated in Asia. Together with businesses in Latin America and the Middle East and Africa, these markets generated 54.81% of the bank’s income. The Asian business was also highly lucrative: local franchises accounted for almost 70% of the half-year profit.

Standard Chartered is even more concentrated in the emerging markets. Asia, the Middle East and Africa provided 88% of the bank’s operating income and 97% of profits in the first half of this year. The largest contributor is greater China, which accounted for a third of the bank’s revenue and almost 64% of profits.

Next in line

The country with the next-largest emerging market exposure is the US with $757.7bn. However, developing markets are responsible for only 5.7% of total claims of the banking sector, a little over a third of what they are in the UK (see chart three). Spain, on the other hand, has $503.2bn worth of claims on emerging economies, amounting to 15% of total claims. 

Claims on developing countries as share of total claims Q1 2015

International activity in Spain is almost exclusively in the hands of just two banks, Santander and BBVA. The two have traditionally sought yields in Latin America, although unit performance in formerly lucrative locations such as Brazil has been muted of late.

Still, Latin America looms large on the balance sheets of the two banks. Operations in the region produce 44% of Santander’s net operating income, while at BBVA they account for 55%, according to the most recent half-year results. At Santander, profits from South America amount to 38.3% of the total, while for BBVA this figure is almost 60%. This is because the tough market in Brazil has been a drag on Santander, which depends in Latin America for 62.4% of its income. By contrast, BBVA has benefited because of its presence in Mexico, which is faring considerably better: the Mexican franchise provides 64.6% of the bank’s income in South America.

The largest exposure in relative terms comes from Austria, where claims on emerging economies amount to 53%. Nearly all activity is focused in developing Europe, which, while not suffering from the same sort of debt overhang as Latin America and Asia, is still experiencing a slowdown: as revealed in May, the profits of Austrian lenders from central and eastern Europe hit an all-time low in 2014.

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