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Emerging market investments have provided a way for banks in developed countries to overcome reduced growth opportunities in small, maturing, and concentrated home markets, says Standard & Poor’s Ratings. Banks have been attracted to these markets by prospects of wider margins, improving macroeconomic conditions, and higher growth.
“The reality of some of these markets has proved less appealing, however, with volatile profitability, unstable economies, and sluggish growth,” says Jess Martinez, a Standard & Poor’s credit analyst and author of the report. “Investing in emerging markets requires significant resources and capital. More importantly, banks in emerging markets face higher economic and industry risks, a factor that has sometimes been underestimated by western banks in their investment decisions.”

In the mid and late 1990s, financial institutions, mainly from western Europe, acquired banks in emerging markets for a total of more than €65bn. Foreign direct investment targeted banks mostly in Eastern Europe and Latin America. Latin America absorbed 75% of these investments, given the bigger size of the economies concerned. As a result of these investments, foreign ownership in emerging markets has increased to unprecedented levels.

Martinez draws attention in the report to the impact on credit quality of heightened risk profiles and greater reliance on local subsidiaries’ revenues. These have been the two main reasons for which Standard & Poor’s has lowered its ratings or changed its outlook to negative on several Western banks that have invested in emerging markets. In addition, some of those outlooks initially revised to negative have since been changed back to stable, reflecting the good performance of the parent banks’ investments, the turnaround of local subsidiaries, smooth integration of the acquired entities within the parent bank, and, sometimes, reduced risk exposure.

With the bulk of western banks’ investments in emerging markets having already been carried out, more significant acquisitions are not expected. Some additional transactions in Eastern Europe are possible, mainly owing to upcoming privatizations; the size of the investments, however, will be relatively small. No further investments are expected in Latin America. On the contrary, there has been a divestment trend in Latin America, given the heightened risk across this region.

“As the investment spree has ended, current ratings on western banks with an emerging-market presence now reflect these banks’ portfolios, their strategies, and the degree of volatility that we expect in the markets where they operate,” adds Martinez.

“Nevertheless, a meltdown in any market that has significant importance for these banks would have negative rating implications.”