March 4, 2012 9:30 pm
Emerging markets must lead banking reform
When global banks first expanded into emerging markets, the idea was that they would bring greater efficiency and foster competition. And there is evidence it did – for a while. But the financial crisis changed that: faced with the need to deleverage and meet higher capital requirements, they are now reducing their exposure to emerging markets, prompting damaging credit crunches, and using profits obtained from subsidiaries to recapitalise parent banks.
Emerging markets must take action. They should implement a new model of international banking that limits global banks’ expansion. Simultaneously, they should enforce a regulatory framework that ringfences subsidiaries from parent banks’ weaknesses. There could be no better time: global finance is being redesigned to avoid a repetition of one of the worst ever banking crises. The outcome will have important implications for banks’ profitability, solvency and capitalisation. But emerging markets have so far had limited participation in this debate.
Prior to Lehman Brothers’ 2008 collapse, globalisation of the banking system was the prevailing paradigm. The need to recapitalise banking systems in emerging markets in the wake of previous crises created a unique opportunity for global banks to expand. Their presence in emerging markets grew considerably. Within a decade, foreign ownership of banks almost tripled, surpassing 50 per cent of total emerging markets banks’ assets by 2005 (excluding China). It was seen as a strength, granting subsidiaries access to the capital and liquidity of a more solid parent. As a result, the debate on cross-border regulation centred on who would be responsible if the subsidiary became insolvent (the home bank and/or local authorities).
But as the 2008 crisis broke many old paradigms crumbled. Parent companies lacked the capital to meet regulatory requirements. By contrast, subsidiaries had strengthened their financial profile in response to more prudent regulatory frameworks and tighter local supervision. Unlike in other episodes of stress, emerging markets banks became a source of stability. Many eurozone banks face a vicious circle of lower profitability, limited growth, higher delinquencies and write-offs, and higher capital requirements. So they are either turning to subsidiaries in search of profits, liquidity and capital, or reducing their exposure to emerging markets banks by deleveraging and selling assets.
Emerging Europe and Latin America have the most to fear from eurozone banks’ weaknesses. In eastern Europe, foreign subsidiaries accounted for more than 70 per cent of total assets, but recently foreign banks have been reducing their exposure there. Latin America has a lower exposure to western European banks but the deleveraging process is also affecting subsidiaries.
A case in point is Mexico. After the 1994 “tequila” crisis, the government bailed out depositors and implemented reforms to rescue Mexico’s banking system. Since local investors were unwilling to inject fresh capital, foreign participation to recapitalise banks was allowed. After this recapitalisation and a balance-sheet clean-up, banks achieved higher profitability, leading to an rise in dividend payments. In short, this has been an incredibly profitable business for international banks.
Not for Mexico, though. The value of the five largest banks (at two times book value) is about $75bn. Moreover, between 2003 and 2011, dividends paid by foreign-owned banks were $20bn (approximately what was paid for the banks), a dividend pay-out of three-quarters of annual profits. If they had followed instead the one-fifth average pay-out of local banks, more capital would have been deployed in Mexico. The credit to gross domestic product ratio would be 5-15 percentage points higher than the current 23 per cent.
Today domestic savings are being used to recapitalise foreign banks, depriving Mexico, and emerging markets generally, of resources.
Emerging markets should consider obliging subsidiaries of global banks to limit dividend payments and/or to list on local stock markets. The listing of subsidiaries would align the bank’s interests with those of host countries, and probably moderate the transfer of resources to parent companies. Action is called for sooner not later.
The writer is chairman of Grupo Financiero Banorte, and formerly governor of Banco de México and Mexican minister of finance
Copyright The Financial Times Limited 2012.
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