Why East Europe suffered a banking crisis and how Latin America escaped?

I had once attended a speech by then Mexico Central bank Governor Guillermo Ortiz. The crisis was just taking shape and he remarked – “Thank got this time it was not Latin America.” The history of Latin America has been such that either crisis originate there or they suffer big time because of crisis conditions elsewhere.

In this crisis it has been a big surprise. Neither they originated it nor they suffered big time. As per recent IMF WEO estimates Latam have done far better than expected or compared to previous crisis.

  Jan 2010 Proj Oct 09 Proj
  2008 2009 2010 2011 2010 2011
Western Hemisphere 4.2 -2.3 3.7 3.8 2.9 3.7
      Brazil 5.1 -0.4 4.7 3.7 2.5 3.5
      Mexico 1.3 -6.8 4 4.7 3.3 4.9

Apart from economy, banking systems have remained stable as well. When financial channel of the global crisis was kicking hard post Sep 2009, there were concerns that Latin American banking system would be a concern as there are number of foreign banks present. However, Latam was ok but concerns were seen in a different region – East Europe.

IMF economists explain why this difference in these two regions.

Foreign banks followed different organizational models ion both regions.

A key difference is the role foreign banks played in sustaining rapid domestic credit growth during the precrisis period. In emerging Europe, globally operating banks from western Europe (mostly from Austria, Belgium, Italy, and Sweden) fueled a credit boom in most countries. These banks transferred large amounts of capital to their subsidiaries, which in turn lent these funds domestically (see Chart 2). As a result of the aggressive expansion strategy of western banks, most of the domestic banking systems in emerging Europe became dominated by global banks—in a number of countries their market share skyrocketed to over 90 percent.

In Latin America, on the other hand, the pace of foreign banks’ credit growth was more moderate, and subsidiaries’ lending was much less reliant on external funding from parent banks in advanced economies (most of which were from Spain, the United Kingdom, and the United States). At the same time, the degree of foreign ownership of the banking sector was in general lower, although in some countries, particularly Mexico and El Salvador, there was a large presence of foreign-bank affiliates.

The source of financing was different. In East Europe funding came from foreign parents and in Latam from local deposits

In Latin America, local affiliates were funded primarily through domestic deposits (which were relatively stable during the crisis), rather than through loans or capital transfers from parent banks. Lending by foreign banks’ local affiliates in Latin America was thus less vulnerable to sudden withdrawal of short-term external funding and contagion from the international liquidity squeeze, and continued to expand even amid the global turmoil.

In emerging Europe, on the other hand, lending by foreign-owned banks depended to a great extent on parent banks in western Europe, which experienced significant financial stress and faced tight interbank liquidity conditions during the crisis. This prompted a cutback in funding to local affiliates, which in turn reduced lending in host markets.

The funding led to different loan portfolio:

The currency makeup of foreign-bank lending appears to be different as well. In Latin America, 60 percent of foreign-bank lending is denominated in local currency. Domestic financial dollarization is low in most of the large Latin American countries and has been systematically declining in the more dollarized ones over the past decade.

In emerging Europe, 60 percent of foreign-bank lending is denominated in foreign currency. Given that local subsidiaries relied on foreign-currency funding from abroad and needed to keep their assets and liabilities currency-matched, foreign banks lent mostly in euros rather than in local currency.

Great insights.


2 Responses to “Why East Europe suffered a banking crisis and how Latin America escaped?”

  1. A degree of hope. : An article from: Mortgage Banking Says:

    […] Why East Europe suffered a banking crisis and how Latin America … […]

  2. What if Denmark was part of Europe? « Mostly Economics Says:

    […] in most crisis – excessive consumption financed by foreign funds, poor fiscal management, foreign banks lending  in euro currency, […]

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