Analysts continue to wonder whether certain European banks face problems from Turkey's financial crisis.

Some European banking groups are exposed to the financial crisis unfolding in Turkey, and among these are lenders in Italy and Spain with weaknesses of their own, according to BNY Mellon.

Turkey, which is embroiled in a deteriorating protectionist trade fight with the US, has seen its lira currency crash 41 per cent against the dollar so far this year; in the past month alone, it has fallen 23 per cent.

The last bout of selloff happened after President Donald Trump tweeted that he will double tariffs on steel and aluminium imports from Turkey. (The US has fallen out with Turkey on a number of issues, including Turkey’s arrest and detention of a pastor.) Worries about Turkey have spread to some other emerging market countries, such as South Africa. At the start of this week, equity markets worldwide sold off, while money went into safe-haven assets such as US Treasuries and the Japanese yen.

The country’s economic woes are not new, however, and have been developing for some time, argued Lale Akoner, market strategist in BNY Mellon Investment Management’s Global Investment Strategy group. 

“The risk to the European banking sector looks to be concentrated in a few banks (BBVA, UniCredit and BNP Paribas). Among these three lenders, Spain’s BBVA (about 14 per cent of loans exposed to Turkey) and Italy’s UniCredit SPA (about 4 per cent of loans exposed to Turkey) are the ones at most risk due to exposures to Turkey.  Another important point to note is that both BBVA and UniCredit are in peripheral Europe, which potentially recreates a sovereign-bank loop,” Akoner said.

In the case of BBVA, the Spanish group controls 49.9 per cent of Turkish bank Garanti after raising its stake in February last year. Garanti Bank, which has a book value of €4.4 billion ($5 billion) for BBVA, had $84 billion in assets as of 30 June (source: Reuters). Garanti accounts for around 13 per cent of group earnings. Deutsche has estimated that in a worst case scenario, this will wipe around 12 per cent off BBVA's group equity.

As for UniCredit, Italy's biggest bank owns around 40 per cent of Yapi Kredi, Turkey's fourth-largest bank, through a local joint venture. Deutsche Bank estimates a 4 per cent hit to UniCredit's equity in a worst case scenario. 

The Netherland’s ING has a fully-owned subsidiary in the country, ING Turkey. Reuters quoted Deutsche Bank analysts as saying that a worst case scenario would translate into a hit of around 4 per cent for ING's book value due to the loss of equity as well as of intragroup funding. BNP Paribas and HSBC have some business exposure. BNP Paribas controls 72 per cent of the Economy Bank of Turkey (TEB), partly through a local joint venture. Turkey accounts for an estimated 2.5 per cent of BNP Paribas' pretax profit. In a worst case scenario, the banking group would lose 1.7 per cent of its net book value, according to Deutsche Bank. 

Akoner said Turkey suffered from a range of problems.

“Turkey has been one of the most ‘vulnerable’ EMs [emerging markets] since 2013 on the back of fundamental problems in its economy: macro imbalances; political uncertainty; central bank’s ‘failure to deliver’ rate hikes (in light of elevated inflation) attributed to its loss of independence; and a broader sense of heterodox policy,” she said in a note.

“Going forward, Turkey’s inflation is likely to rise further and push the economy into recession accompanied by a possible banking crisis. Much of the concern is focused on Turkey’s banks, which have increasingly resorted to foreign wholesale markets to finance their domestic lending (about a third of bank lending is in foreign currencies, mostly to corporates),” she continued. 

“Although weakness in Turkey would be another blow to the EM asset class in general, the wider economic spill-over on other EM economies will likely be limited. In general, those countries that used to share similar vulnerabilities with Turkey, for example the `Fragile Five’ countries - Brazil, India, Indonesia, and South Africa - all had large current account deficits, and indeed suffered the largest currency falls during the Taper Tantrum, have improved their fundamentals since the Taper Tantrum.  Therefore, in our view, Turkey is mostly the exception and not the rule, and not necessarily demonstrative of the larger EM complex. Nevertheless, what is largely an idiosyncratic risk for Turkey did feed into the negative sentiment towards EMs in general,” Akoner said. 

“It brings back the fundamental worry that investors have against EMs, the global liquidity dry-up through G-4 central bank tightening.  This could make the financial conditions for emerging economies more difficult.  Adding to this fundamental worry would be the concerns surrounding the US-China trade war (i.e. what does it say for Trump’s overall trade policy when the US imposes tariffs on a NATO ally?)” she added. (Turkey is a member of NATO, and the US has operated bases inside the country.)

Worsening
At Capital Economics, the UK-based organisation said that conditions are likely to worsen. 

“The plunge in the Turkish lira is likely to push inflation above 20 per cent and tip the economy into recession in the coming months. Our base case is that GDP growth will now average 3.0 per cent over 2018 as a whole (thanks to a strong first half of the year) and be flat over 2019. Our previous forecasts were +3.5 per cent and +2.5 per cent respectively. It now looks more likely than not that the central bank will refrain from hiking interest rates significantly. However, there is a real risk that banks and corporates could struggle to roll over external debts, making the crisis more acute,” the organization said. 

Turkey’s fall from financial grace is ironic; a few years ago, the country was seen as something of a potential wealth management hotspot. 

About two years ago, a failed "coup" in Turkey (some commentators were not convinced whether this was a genuine coup or not) saw a crackdown by the current regime.

Separately, on a more positive note, however, Michalis Ditsas, head of investment specialists at SYZ Asset Management, argues that European banks in general deserve more investor respect than share prices reflect. “Despite the recent market gloom over the banking sector, the financial system continues its balance sheet strengthening, with higher levels of equity capital and improved asset quality. Eurozone banking institutions have piled on billions of fresh equity capital since the end of 2010, at the same time reducing their bad loan exposure from 2015 peaks to the current Nonperforming Loan (NPL) ratio of 4.9 per cent,” Ditsas said in a note.