Evans-Pritchard - European banks face double hit from emerging market slide and ECB crackdown

OECD warns bond tapering by Fed has “only just begun” and threatens to trigger a fresh wave of capital flight

By Ambrose Evans-Pritchard

11 March 2014

The deepening slowdown in emerging markets is holding back global recovery and risks fresh financial strains in Spain, Britain and other European countries with large bank exposure to the bloc, the OECD has warned.

Rintaro Tamaki, chief economist for the OECD club of rich states, said bond tapering by the US Federal Reserve has “only just begun” and threatens to trigger a fresh wave of capital flight from vulnerable parts of the emerging market nexus. “There remains a risk that capital flows could intensify,” he said.

Mr Tamaki said Spanish bank exposure to developing countries is 35pc of Spain’s GDP, mostly through the operations of Santander and BBVA in Latin America. Exposure is 21pc for Britain and 18pc for Holland. The US is largely insulated at just 3pc of GDP.

Much of Britain’s link is through lending to Chinese companies on the dollar market in Hong Kong. British-based banks account for almost a quarter of the estimated $1.1 trillion of foreign-currency loans to China.

The OECD called on the Fed to go easy on bond tapering and said the European Central Bank and the Bank of Japan may have to step up stimulus to prevent the recovery faltering.

Mr Tamaki said the OECD’s leading indicator gauge for emerging markets peaked in January 2011 and has been declining relentlessly ever since, now made worse as Turkey, South Africa, Brazil, India and others tighten monetary policy to defend their currencies. “Given that emerging economies now account for more than half the world economy, the slowdown is likely to be a drag on global growth,” said the body.

European banks are already under pressure from the ECB’s forthcoming stress tests. An ECB manual published on Tuesday signalled that these will be far more intrusive than previous rounds of tests by national regulators, widely viewed as a fiasco.

Banks will no longer be allowed to cover up the true scale of non-performing loans by waiting for 120 or even 180 days before coming clean. “We will strictly enforce the 90-day rule,” said an ECB official.

Once a borrower misses a payment by 90 days on any of its debt, everything it owes will be classified as a bad loan. The ECB will also carry out its own spot checks on €3.7 trillion of assets rather the letting banks reach their own rosy assessment, especially for “Level 3” assets that cannot easily be traded. “We will look closely at the trading books of around 30 large banks with Level 3 assets to see whether they are properly classified,” said one official.

The ECB appears confident that the eurozone recovery is strong enough to withstand a tough approach, which could force banks to cut lending to meet capital ratios, and even lead to closures.

Bank stocks barely moved on the new guidelines. Italy’s Unicredit rose more than 6pc despite a record loss of €14bn in the fourth quarter to cover bad loans from costly takeovers in Austria and central Europe. Investors were comforted by plans for a cost-cutting purge.

Yet the ECB clampdown is a risky strategy at a time when EMU-wide private sector lending is contracting at 2.3pc, with a deep credit crunch for small firms in southern Europe.

“I am very concerned about this,” said professor Richard Werner, from Southampton University. “There is a high risk that it could force banks to reduce lending. It could push banks in the periphery to the edge but it could also put pressure on smaller banks in Germany that provide 70pc of loans for small firms.

“The ECB is far too tight already. Germany is providing the last speck of growth in the eurozone but even this is now threatened."