The massive plunge in the Turkish lira – the currency has depreciated by more than 70% against the US dollar since the beginning of April – accelerated especially during the course of last week, moving Turkey’s economic problems onto the front burner and into the front of market actors’ minds. It is not much of a surprise that equities and bonds issued by Turkish banks have come under pressure in such an environment, but many market watchers are using the metaphor of a “ticking time bomb“ and fear possible contagion effects spreading to other developing countries and other banking systems.
Accordingly, a number of European banks have moved more and more into the focus of market participants – at the latest in the wake of the article published in last Friday’s edition of the Financial Times (FT) arguing that the ECB Banking Supervision has become increasingly concerned about lenders with large exposures to Turkey in the light of the Turkish lira’s dramatic fall. The FT takes the line that the ECB sees above all the major banks BBVA, BNP Paribas and UniCredit as being particularly exposed but that it “does not yet view the situation as critical.” The ECB has not itself commented on this newspaper report. True, risk premiums on the bonds of the banks in question have not reacted so violently, but the spread performance of their debt issues has nevertheless been among the worst in the iBoxx Banks universe over the past week.
What risks are in fact facing Europe’s banks? For one thing, there are likely to be more defaults, above all in the case of borrowers who have incurred debts in foreign currencies and are no longer able to service these following the slide in the Turkish lira. By way of example, the rating agency Moody’s is assuming that the proportion of non-performing loans (NPL ratio) is going to increase sharply over the next twelve to eighteen months. Via higher risk costs, a deterioration in credit quality will weigh on the, to date, strong profitability of Turkish banks. Furthermore, stakes in Turkish subsidiary banks will lose value and need to be written down to the extent that the book value of the stakes has not been hedged. Parent banks could also suffer a decline in earnings contributions from subsidiaries or stakes generated on a Turkish lira basis. In the event of solvency problems emerging, moreover, intra-group loans to foreign subsidiary banks could be in jeopardy or else there could be a need to inject fresh equity.
Which European banks could be affected on this score? It is indeed the banking institutions named in the FT article which have the largest exposures to Turkey, above all the Spanish banking group BBVA, active in the Turkish market via its subsidiary Garanti, which is, after all, the country’s third-largest bank. For BBVA, Turkey is now the second-most-important foreign market after Mexico, with Garanti contributing approximately 14% to the major Spanish bank’s consolidated result in the first half of 2018. In the shorter term, BBVA would find it manageable to absorb the loss of the earnings contribution from Turkey, and the possible eventuality of the subsidiary’s goodwill needing to be written off completely, without recording a net loss, and negative repercussions on the bank’s capitalisation will be cushioned by hedging measures. Should the Turkey crisis drag on for years, however, the long-term consequences would be more difficult to assess because loss contributions, possible recapitalisation measures and, as a last resort, an emergency sale could add up to a more onerous overall burden. It has to be concluded, though, that the NATFA renegotiations, with possible knock-on effects on the Mexican economy, are of considerably greater significance for BBVA than the current crisis gripping Turkey.
In contrast to BBVA, UniCredit, to take that example, does not have a subsidiary of its own in Turkey, rather holding a 40.9% stake in the Turkish bank Yapi within the framework of a joint venture. Yapi’s net result therefore contributes to the Italian group’s consolidated result on a pro-rata basis via dividend returns. Given, however, that the stake in Yapi is not a principal source of revenue for UniCredit, potential earnings losses ought to prove manageable for Italy’s biggest banking group. Admittedly, UniCredit’s capital ratios, which are rather on the low side in any case, could be squeezed if the Turkish lira continues to lose altitude.
The inference to be drawn, then, is that a further escalation of the situation in Turkey would indeed entail earnings losses for European banks with a presence in the local market, but that such burdens would turn out to be manageable thanks to the diversified nature of their banking activities.