Is the Australian Banking Sector Exposed to Europe?

Australian banking stocks have come under selling pressure due to fears of a contagion effect from Europe's debt crisis.

Australian banks have yet again demonstrated good risk management in avoiding massive loan exposures to troubled European economies, particularly the PIIGS (Portugal, Italy, Ireland, Greece and Spain). Direct loan exposures to PIIGS countries are nil at best and immaterial at worst.

The September quarterly report from the Swiss-based Bank of International Settlements includes national banking system counterparty loan exposures at 31 March 2011. The Australian banking system reported total direct loan exposures of US$25.9bn to European countries, with France the highest at US$9.2bn, followed by the Netherlands at US$7.5bn and Luxembourg at US$2.5bn.

Aussie banks reported direct loan exposures to Italy of 'just' US$696m and zero direct loan exposures to Portugal, Ireland, Greece, and Spain. The four major banks report combined gross loans of A$1.8 trillion, so the US$25.9bn total across the entire Australian banking system represents only 1% of the major banks' total loans outstanding.

The most dramatic change for Australian banks is their exposure to Spain, which has been cut to zero from $US1.69 billion this time last year. A further $US71 million has been pulled from Portugal. Loans to Italy have increased to $US696 million from $US586 million in the December quarter.

The potential for serious sovereign debt contagion pushed Australian banks to reduce European country loan exposures over the past year, with all four major banks running relatively small net interbank exposures with major European banks. In most cases, each side of these interbank and counterparty transactions provide collateral to each other, often in the form of cash. All exposures are managed on a daily basis and additional and better quality collateral can be required at contract rollover and/or with new transactions.

Major Australian banks typically only transact with 'national champion' banks when trading with offshore banks, and avoid dealing with second and third-tier banks. Following the collapse of Lehman Brothers in September 2008, major Australian banks only extend lines/limits to banks that are domestically significant in their home markets and are likely to receive government support should solvency issues arise.

Commonwealth Bank (CBA) is confident it and Australia are in better shape to deal with the European sovereign debt crisis than they were before the global financial crisis three years ago.

CBA recently confirmed very small exposures to French and German banks through derivatives trading and small transaction limits. Gross exposure to French banks is 0.6% of total gross credit exposures. Gross exposure to German banks is also 0.6% of total gross credit exposures.

National Australia Bank (NAB) reported exposure to European sovereigns of A$1.8bn at March 2011, with an additional A$11.8bn to European banks including the UK region (where of course NAB has direct ownership of two relatively well performing UK banks), and banks with government guarantees.

NAB's exposure to PIIGS is less than 0.5% of total gross credit exposures. Westpac's (WBC) net exposure to European banks is relatively small. ANZ Bank's (ANZ) exposure to Europe is very modest with no material direct exposure to weak European sovereigns. ANZ's principal counterparties are in major European economies such as the UK, Germany, and Switzerland.

While the direct exposure to European debt is minimal, the volatile trading conditions have seen the cost of wholesale funding increase. With the national savings rate at a two decade high, large retail deposits should partially cushion Australian banks against higher funding costs as margins are likely to be squeezed.

http://www.sfg.com.au/Knowledge-center/News/Articles/October-2011-%281%29/Is-the-Australian-Banking-Sector-Exposed-to-Europe.aspx