The global financial crisis has had a major impact on banks worldwide. While some banks are faced with major restructurings (either voluntary or imposed by governments), (almost) all banks will have to make adjustments in order to comply with Basel III and other, country-specific regulatory measures. The changes induced by the crisis, however, will have a very different impact on advanced country banks compared to emerging-market banks. How will this shift in balance impact the global financial system?
Crouching tiger, hidden dragon
Although many in the West are not familiar with emerging-market banks, they are by no means small. In fact, the world’s biggest bank in market value is China’s ICBC. The global top 25 includes eight emerging-market banks. Among these, three other Chinese banks (China Construction Bank, Agricultural Bank of China, and Bank of China), three Brazilian banks (Itaú Unibanco, Banco do Brasil, and Banco Bradesco) and one Russian bank (Sberbank). While excess optimism might have inflated these market values, these banks are large with respect to other measures as well. In terms of assets all these banks are in the top 75 worldwide, with all four Chinese banks in the top 20. Furthermore, in 2010 emerging-market banks as a group accounted for roughly 30% of global profits, a third of global revenues, and half of tier 1 capital.
Not only are emerging-market banks already substantially large; they are catching up rapidly. Asset growth has been impressive in many emerging markets. Although China again tops the ranks, other emerging markets have seen impressive increases in bank assets as well. While emerging-market banks already grew faster than their advanced-country counterparts prior to 2007, the financial crisis has accelerated this trend. The expected continued growth of emerging-market banks and the likely stagnation (or even contraction) of advanced-country banks, many of which still face multiple risks, implies that the relative importance of emerging-market banks will quickly grow.
Differences that count
Several factors make it easier for emerging-market banks to weather the storm caused by the financial crisis. First, loan-to-deposit ratios in general are very low due to the net saving position of these countries. This sheltered emerging-market banking systems to a large extent from the collapse of the interbank market and reduced the need for substantial deleveraging. This allows them now to continue lending using a stable and often growing source of deposit funding. Second, most emerging-market banks already have high capital ratios, limiting pressures for balance sheet adjustments. In addition, the new capital rules under Basel III are likely to be much less painful for these banks as they typically have less risky assets and their investment-banking business tends to be small.
Equally important, emerging-market banks face a very different situation in their domestic market compared to their advanced-country peers. First, a large part of the population in the emerging world is still unbanked. This provides for ample growth opportunities in these markets. In contrast, due to overall economic weakness and ongoing deleveraging among firms and households expected credit growth in advanced economies is low. Second, the macroeconomic outlook in these countries is much better than that of advanced countries. Not faced with major sovereign debt problems nor large current-account deficits, most emerging markets are on pretty solid footing. Even though they will not be isolated from the problems in Europe and the United States, the dependency of these markets on the West has diminished in recent years.
Due to sheer size, emerging-market banks almost undoubtedly will soon become important players in the world’s financial system. It is less clear, however, how far their global reach is going to extend. With still a large part of the population unbanked, most emerging-market banks face pressures at home to increase lending which reduces funds available for foreign expansion. Furthermore, an important share of excess deposits is stuck in sleepy state banks that have shown very limited interest in expanding abroad. In addition, many emerging-market banks have only limited provisions set aside, especially compared to advanced country banks, and therefore are facing pressures to increase their bad debt reserves. Finally, regulators might oppose foreign adventures as the use of domestic deposits to finance a subsidiary overseas exposes the bank to foreign-exchange and counterparty risk.
At the same time a number of factors could as well push these banks into increasing their global presence. First, even with the caveats described above, the funding position of most large emerging-market banks looks good, providing them with relatively large amounts of funds compared to their advanced country counterparts. Furthermore, a number of these banks are highly profitable which allows them to invest and at the same times gives them a buffer to absorb potential losses. Both factors provide emerging-market banks with the means to seize opportunities when advanced-country banks, in need to consolidate, are either forced or voluntarily sell some of their subsidiaries. Further, an increasing number of emerging-market companies are establishing a presence overseas, providing emerging-market banks with opportunities to extend their foreign network in order to service their domestic customers abroad.1 Finally, a substantial number of emerging-market banks are no strangers to setting up branches or subsidiaries in other countries. In fact, in 2009 close to 30% of the foreign banks were owned by emerging-market banks.2 This shows that these banks do have the knowledge and expertise to undertake and manage overseas operations.
Staying close to home
Taking stock, it is to be expected that in the coming years emerging-market banks not only will grow in their domestic market but also will expand their global reach. However, this expansion is likely to be confined to the geographical region of the bank’s headquarters. Research has shown that closeness to their clients makes it easier for banks to do business.3 So profit margins are likely relatively high for emerging-market banks in other emerging markets. Indeed, if we look at the previous expansion of emerging-market banks, 70% of their investments tend to be in countries within their own geographical region.4 Furthermore, with a fully developed banking system, sovereign debt problems, and low expected economic growth, profits are unlikely to be reaped in advanced countries, providing another reason why investments in other emerging markets are more likely. In addition, the regulatory crackdown in advanced countries, caused by some cross-border bank failures, might make it hard for emerging-market banks to set up a branch or subsidiary in these countries.
With advanced-country banks trying to adjust to the new rules of the game, it is unlikely that many of these banks will remain active investors in the near future. Banks from emerging markets, being in a much better financial position, are likely to step into the void left by advanced country banks, increasing their relative importance as foreign investors. The global financial system is therefore likely to witness a shift towards a stronger dominance by emerging-market banks, especially within their own geographical regions.
Disclaimer: The views expressed in this column are those of the author only and do not necessarily reflect the views of the De Nederlandsche Bank, the European System of Central Banks, or their Boards.
Brealey, Richard and EC Kaplanis (1996) “The Determination of Foreign Banking Location,” Journal of International Money and Finance 15: 577–597.
Claessens, Stijn and Neeltje van Horen (2011) “Trends in Foreign Banking: A Database on Bilateral Foreign Bank Ownership”, mimeo, International Monetary Fund and De Nederlandsche Bank.
De Haas, Ralph and Neeltje van Horen (2011) “Running for the Exit: International Banks and Crisis Transmission”, DNB Working Paper No. 279.
Focarelli, Dario and Alberto F Pozzolo (2005) “Where do Banks Expand Abroad? An Empirical Analysis”, Journal of Business 78: 2435–2463.
Galindo, Arturo, Alejandro Micco, and César Serra (2003) “Better the Devil That You Know: Evidence on Entry Costs Faced by Foreign Banks”, Inter-American Development Bank Working Paper No. 477.
Grosse, Robert and Lawrence Goldberg (1991) “Foreign Bank Activity in the United States: An Analysis by Country of Origin”, Journal of Banking and Finance 15: 1092–1112.
1 It is long been established that banks tend to follow their customers abroad (see, among others, Grosse and Goldberg 1991 and Brealey and Kaplanis 1996.)
2 Source: Foreign banking database (Claessens and van Horen 2011).
3 A number of studies show that banks tend to invest in countries that are geographically, legally and/or institutionally close (Galindo et al 2003, Focarelli and Pozzolo 2005). In addition, De Haas and Van Horen (2011) provide evidence that closeness is an important determinant of cross-border lending stability in times of crises.
4 Source: Foreign banking database (Claessens and van Horen 2011).