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Tom Holland

As the crisis-stricken euro zone slides into recession, concerns in Asia are focused on the damage that a slump in European consumer demand will inflict on the region's export industries, and how the resulting decline in shipments will weigh on Asia's economic growth.
But weakening demand in Europe is only half the story as far as the impact of the European debt crisis on Asian economies is concerned.
At least as important will be a reduction of lending in the region by Europe's dangerously weakened banks.
The problem is that euro-zone banks are sitting on several hundred billion euros of sovereign debt issued by Greece, Spain, Portugal and Italy that is now worth considerably less than its original face value.
The unrealised losses have blown a big hole in the banks' balance sheets, and severely damaged confidence in the European banking system as a whole.
In an attempt to restore credibility, in October, Europe's leaders ordered the euro zone's banks to raise their core capital ratio to at least 9 per cent of their assets.
The authorities' idea was that 70 banks should raise  about Euro106billion (HK$1 trillion) in fresh capital from the market.
But with raising capital a tall order in current market conditions, Europe's banks are instead opting to boost their capital to asset ratios by scaling back the assets they hold.
In effect that means reducing their lending. And with Europe's banks under intense political pressure to maintain the supply of credit in their home markets, the cuts are set to fall disproportionately on Asia.
The impact will be painful. Since the 2008 financial crisis, European banks have been ramping up their activity in Asia. In March this year, they had outstanding loans to Asian (excluding Japanese) borrowers worth a hefty US$1.5 trillion, some 20 per cent higher than in mid-2008.
European banks are especially big players in Singapore, where they account for 68 per cent of local credit, and in Hong Kong, where they provide 63 per cent of total credit (see the first chart  above).
To be fair, these figures are distorted by the presence of HSBC and Standard Chartered, which although based in Britain, finance much of their Asian lending through local deposits.
But if you strip out lending by British banks, then continental European lenders are still major players in Asia. Across the region, they account for 21 per cent of cross-border funding, half as much again as their US competitors.
As a result, any reduction in European bank lending will have a big impact in the region, especially on the availability of trade finance. Already the prospect of a pull-back is stirring nasty memories of late 2008, when European banks slashed lending to Asia by more than US$200 billion in a matter of months, halting much of the region's trade in its tracks.
Pessimistic analysts fear a similar financing crunch this time around. But happily their worst fears appear exaggerated.
Since the 2008 crisis, the US Federal Reserve has put in place a network of swap agreements with Asian central banks to ensure the availability of US dollar liquidity for trade finance.
What's more, although US and European banks have been weakened by the long-running crisis, Asian banks remain for the most part in good shape. As a result local institutions will be able to fill at least some of the funding gap.
With a conservative loan-to-deposit ratio of 70 per cent,  the mainland's banks in particular have the potential to ramp up their cross-border financing, stepping into the space vacated by retreating European lenders.
And following yesterday's cut by the People's Bank of China's required reserve ratios, Chinese banks will have more of those resources available to lend.
As a result, although the economic pain inflicted on Asia by the withdrawal of European bank lending could prove severe, let's hope  it will be a lot more bearable this time around than in 2008.



Hard times ahead as Europe's banks cut lending to Asia