International bank balance sheets continue to contract, and European banks are most exposed to troubled sovereign credits in the region, according to the latest quarterly statistics released by the Bank for International Settlements.

The BIS reports that banks’ international balance sheets contracted for the fifth consecutive quarter in the final three months of 2009. International claims fell by US$337 billion, as banks steered funds towards the faster-growing regions of the world, and away from the ones where the pace of economic recovery was sluggish, it says.

European banks were particularly exposed to Greece, Ireland, Portugal and Spain, accounting for almost two thirds of all BIS reporting banks’ exposures to these countries, it says. Within the euro area, French and German banks had the largest exposures (US$493 billion and US$465 billion, respectively).

Banks headquartered in the United Kingdom had larger claims on Ireland (US$230 billion) than banks based in any other country.

Spanish banks were the ones with the highest level of exposure to the residents of Portugal (US$110 billion).

The BIS notes that issuance of international debt securities recovered in the first quarter of 2010, as announced gross issuance went up by 27% from the previous quarter to US$2,249 billion, and net issuance almost doubled to US$595 billion.

Activity on the derivatives exchanges also accelerated during the first quarter of 2010. Turnover measured by notional amounts of futures and options on interest rates, stock price indices and foreign exchange increased by 16% quarter-on-quarter to US$514 trillion between January and March. And, positions in over-the-counter derivatives increased modestly in the second half of 2009, as notional amounts outstanding edged up by 2% to US$615 trillion by the end of December. Exceptions to the upward trend were OTC derivatives on commodities and credit default swaps, whose volumes outstanding fell by 21% and 9%, respectively. Reporting banks’ gross credit exposures continued to fall, albeit at a slower rate, declining by 6%, after an 18% decline in the first half of 2009

The report explains that, “Global financial markets were highly volatile from mid-April to early June as fiscal concerns and the risk of weaker growth caused investor confidence to deteriorate rapidly. Investor worries about unsustainable fiscal positions crystallized around the problems of Greece and other euro area sovereigns. Faced with growing uncertainty, investors cut risk exposures and retreated to traditional safe haven assets.”

The BIS notes that while the announcement of a significant European rescue package bought a temporary reprieve from contagion in euro sovereign debt markets, it could not allay market concerns about the economic outlook. “Instead, the flight from risky assets continued, resulting in additional increases in risk and liquidity premia,” it says.

Doubts about the robustness of global growth were sown on a number of fronts, it observes. In advanced economies, the rise in public debt is the big worry. There are growing concerns that the financial system is more fragile than previously thought. Policy tightening in China, Brazil and India, and elsewhere drove doubts that emerging economies will be able to sustain global growth. And, rising geopolitical risk hurt market confidence, too.

IE