The European Central Bank has issued a warning about the potential impact of the lira plunge on euro zone banks that are severely affected by the Turkish economy.

Turkey is in the midst of another wave of years of currency crisis. So far this year, the lira has fallen by nearly 40% against the US dollar, making it the worst-performing emerging market currency. The currency’s current exchange rate against the U.S. dollar is slightly higher than 13 units, compared to 7.44 in January and 3.78 in early 2018. Only one day this month (November 23), the currency plummeted by nearly 20%, and then rebounded slightly. The main reason for the collapse was the decision of the Central Bank of the Republic of Turkey to lower interest rates for the third time since September, despite the sharp drop in the lira and the soaring inflation.

Contagion risk

In August 2018, at the last wave of Turkey’s protracted crisis, the European Central Bank warning Regarding the potential impact that the lira plunge may have on euro zone banks, these banks have provided large amounts of loans through banks acquired in Turkey — most of which are in euros — and the impact on the Turkish economy has been significant. The central bank worried that Turkish borrowers might not be able to hedge against the weak lira and began to default on foreign currency loans, which accounted for 40% of Turkish banking assets.

In the end, the risk of infection is basically controlled. Many Turkish banks eventually agreed to restructure the debt of their corporate customers, especially large companies.At the same time, the Erdogan government used state-owned lending institutions Rescue millions of needy consumers By restructuring their consumer loans (many of which are foreign-denominated) and credit card debt.

But concerns about European banks’ exposure to Turkey have risen again. On Friday, as these concerns were intertwined with concerns about the potential threat posed by the new omicron variant of Covid-19, Europe’s most affected stocks included the four banks with the most exposure to Turkey: Spain’s BBVA, whose share price It fell 7.3% on the day, with Italy’s Unicredit (-6.9%), France’s BNP Paribas (-5.9%) and the Netherlands’ ING (-7.3%).

The devaluation of the lira will almost certainly increase Turkey’s inflation. In October, the country’s consumer price inflation has reached a staggering 20%. This is still not as high as the 25% peak value set in 2018, but it may be higher as the lira weakens. As prices soar, which further erodes the savings and income of many Turks, the risk of social and political unrest will also increase. Another cause for concern is that the depreciation of the lira will make it more difficult for companies already affected by the virus crisis to repay their foreign currency debts.

The silver lining of the Turkish economy is that the depreciation of the lira promotes exports while making imports too expensive for many people.Even before the currency’s most recent plunge, Turkey Registered August and September saw current account surpluses for two consecutive months-a rare feat for a country that relies so heavily on imports.At the same time, as the Guardian, Erdogan, who maintains de facto control over the Central Bank of Turkey, continues to follow closely behind in interest rate policy. report:

[…] Recep Tayyip Erdo?an announced the launch of the “War of Economic Independence”, which made him oppose many people in his party and worried that a 20% inflation rate would trigger further social unrest. bureaucracy.

“Some people who want to convey to the president that they should follow different policies have not succeeded in this regard,” a senior official of the ruling AK Party told Reuters, requesting anonymity.

Since mid-2019, three central bank governors who opposed Erdogan’s request to lower interest rates have been dismissed. These are the three separate interest rate cuts by Governor ?ahap Kavc?o?lu since March to lower the benchmark interest rate from 19% to 15%. Paved the way.

Reduce exposure

So far, Spanish banks have the highest loan exposure to Turkey, with nearly 63 billion U.S. dollars in outstanding loans, followed by France (26 billion U.S. dollars), Germany (14 billion U.S. dollars) and Italy (6 billion U.S. dollars). according to The latest data from the Bank for International Settlements. The good news for the European Central Bank is that since 2018, some Eurozone banks with large-scale operations in Turkey have reduced or at least not increased their exposure to the country.

Unicredit, a major Italian bank Sold out Its stake in the commercial bank Yapi Kredi has increased from 40% in 2018 to around 20% today. Based on a strategy aimed at offloading non-core assets, the bank’s current business plan envisages zero contribution from Yapi by the end of 2023. Nevertheless, according to Citi analyst estimates, Yapi Kredi will still contribute about 5% of the group’s revenue by 2021.

French giant BNP Paribas operates a variety of businesses in Turkey, from retail banking to leasing and insurance, through a series of subsidiaries. But according to Jeffries, the country’s contribution to BNP Paribas’s profits is very low. More importantly, BNP Paribas claims that most of its Turkish operations are self-funded.

Another European bank operating in Turkey is the Dutch group ING, but its risk exposure is also limited. In 2020, it generated 420 million euros in total revenue in the country, making it the third largest market outside of Europe for ABN AMRO after the United States and Australia. Turkey’s assets in 2020 are approximately 7.3 billion euros, accounting for less than 1% of the total assets of 937 billion euros.

Buck the trend

There is one big exception to this trend: BBVA, Spain’s second largest bank. In 2020, Turkey is BBVA’s third largest market after Mexico and Spain, providing a net profit of 563 million euros, an increase of 41% over 2019. This accounted for 14.3% of BBVA’s profits, excluding corporate centers.

Until two weeks ago, BBVA owned less than 50% of the shares of Garanti, Turkey’s second largest private bank. Paid Incremental purchases starting in 2010 were 6.9 billion euros. Since then, the lira has done nothing but a fall. The market value of Garanti two weeks ago was 3.7 billion euros converted to euros (now 3.3 billion euros). BBVA holds 49.85% of shares worth 1.85 billion euros. In other words, BBVA lost 73% of its investment.

However, BBVA did not reduce its exposure to Turkey, but doubled it. After BBVA sold its U.S. subsidiary to PNC last year, it has ample cash. It announced two weeks ago-just days before the Turkish Central Bank cut interest rates for the third time, triggering the worst daily collapse of the lira in 20 years-planning to buy the rest of Garanti. The price of the share TL12.20. This move is equivalent to a large-scale gambling on Turkey’s Erodgan-led economy, and it has not been favored by investors. Since the date of the acquisition, BBVA’s stock price has fallen by nearly 20%, and Garanti’s stock price is now lower than the purchase price.

“This is our best investment option,” Said BBVA CEO Onur Genç said on an investor conference call on Monday that it aims to alleviate shareholder concerns. The Spanish bank sees its purchase of Garanti as a long-term proposal to consolidate its position in the high-growth market it knows-and at a cheaper price! Genç, who has Turkish descent, said that even with the recent depreciation of the lira, this has weakened Garanti’s market value, but it is good for BBVA because it means that its offer for Garanti (converted to euros) has fallen from 2.25 billion euros that day. BBVA announced today Up to 1.8 billion euros. At the same time, the amount of committed capital has dropped from 1.4 billion euros to 1.2 billion euros.

However, although the lira plunge may mean that BBVA’s transactions are getting cheaper, it may still end up paying a high price.as a Reuters breakthrough view article Cross post on nation Point out that this crisis may hurt Garanti in two ways:

First, the depreciation of the lira makes it more difficult for borrowers to repay debt denominated in dollars, increasing the risk of default. Garanti reduced its foreign exchange exposure much faster than other banks, but it was still US$11.6 billion (EUR 10.3 billion), which still accounted for almost one-third of total loans. Second, unorthodox monetary easing increases the possibility of a sharp rise in interest rates at some point in the future. This will reduce loan profit margins because deposits will immediately become more expensive, and loans will take longer to appreciate.

But the CEO of BBVA is temporarily at a loss, or at least it seems so. “From the beginning,” he Said, “We have realized the risks and controlled them in a variety of ways.” A typical example is the way BBVA established its global business to limit the spread of financial wildfires from Turkey or other emerging markets to wider groups, as Bloomberg Recent articles Point out (In parentheses are my own comments):

As a legacy of the Argentine debt crisis in the late 1990s, the bank adopted a self-sufficient subsidiary model, where it can be isolated from other departments if one of its businesses encounters trouble. This means that if Garanti starts to fail, it can be liquidated or reorganized without affecting the other members of the group. In the worst-case scenario, BBVA will risk the value of its equity in Garanti-currently just under US$4 billion.

In other words, BBVA will simply stay away from the smoldering wreckage and Turkey as a whole-at least in theory.one thing Bloomberg The article does not mention that BBVA’s silo-based damage control system has never been properly road tested before.