IN FOCUS6-8 min read

Three reasons why an EM banking crisis may be avoided

Concerns over the health of the global financial system are likely to cause volatility, but we don’t see a crisis brewing following US banks' wobble.

EM bnaks


David Rees
Senior Emerging Markets Economist

The old saying goes that the Federal Reserve (Fed) raises interest rates until something breaks. There were idiosyncratic factors behind the demise of US regional banks SVB and First Republic, but aggressive interest rate hikes are likely to have played at least some part. And while the sell-off in global banks has since eased, as the dust settles the early indications are that the shock to confidence has resulted in some tightening of US credit conditions. This tightening adds to the list of reasons to expect a US recession later this year.

Fed hiking cycles have in the past exposed EM banking vulnerabilities

Emerging markets (EM) have had their fair share of banking and financial crises down the years as previous interest rate cycles have exposed vulnerabilities. While no two crises are the same, problems in EM have often been preceded by a period of rapid capital inflows that have fuelled a pickup in credit growth. As overheated demand leaks into imports, large current account deficits funded by this “hot money” leave EMs vulnerable to a sudden stop as monetary conditions tighten in developed markets, invariably led by the Fed as the most influential major central bank.

Indeed, we’ve seen sudden stops of capital inflows occur many times in the past after the Fed has raised interest rates. During these periods, we’ve seen how the sudden tightening of domestic financial conditions as a result of these circumstances can very quickly feed back into the real economy. EM banks have then suffered the blowback from subsequent recessions and rising loan defaults.

Some of the conditions that have preceded past EM crises are present today. Certainly, the Fed has raised interest rates very aggressively with the 475 basis points of tightening delivered over the past year, larger than in any other hiking cycle in the past four decades. What’s more, there has been a deterioration in the balance of payments of most EMs such that many now have significant current account deficits that are at least partly funded by short-term capital inflows. These issues cannot be taken lightly given the fraught nature of global sentiment, but there are at least three reasons to think we are not on the verge of a major EM banking crisis.

1 - Large capital buffers offer some protection for EM banks

First, top-down metrics indicate that EM banks are generally in good shape. According to the IMF’s Financial Soundness Indicators, regulatory capital to risk-weighted asset ratios are generally well in excess of the Basel III minimum requirements at 15-20% in major EMs. Banks still face the prospect of rising non-performing loans as economic growth slows in the near term, but large capital buffers should offer at least some protection. In addition, loans are generally funded out of deposits, reducing the vulnerability to a freeze in global funding markets.

Em bnaks

2 - Little evidence of excessive bank lending

Second, there is not much evidence of excessive bank lending. One way to identify the early stages of EM crises emanating from the financial system is to monitor credit gaps, such as those published by the Bank of International Settlements (BIS). These measure the deviation of private sector as a share of GDP from long term trends. The idea is that when credit growth exceeds the increase in nominal GDP, the credit gaps rises. Conversely, the credit gap declines when lending expands at a slower rate than the economy. It is always dangerous to generalise about EM, but a quick look at the experiences ahead of the Asian Financial Crisis in the 1990s and problems in Central Eastern European banks in the 2000s show that credit gaps often widen to somewhere in the region of 20-30% of GDP ahead of crises.

em banks

However, the latest data suggest there is little cause for concern. These figures need to be treated with care, after all the credit gaps tells us nothing about the absolute size of the debt stock in highly leveraged markets such as China. However, weak credit demand against a backdrop of sluggish economic growth in recent years means that EM credit gaps are generally negative. Indeed, many EMs would probably benefit from a domestic credit cycle that could drive a period of growth. Two markets to keep an eye on are South Korea and Thailand, where leverage has been increasing.

em banks

3 - Absence of broader macroeconomic imbalances

Third, just as credit growth does not appear to have been excessive, there is not much evidence of broader macroeconomic imbalances that are about to be exposed by higher global interest rates. Admittedly, there has been some deterioration in balance of payments (BoP) positions such that several major EMs now sit in the vulnerable quadrant of our scatter plot where current account deficits are at least partly funded by short-term capital inflows (defined here as portfolio plus “other” flows). The worst offenders are Chile, Romania, Hungary and Colombia amongst others.

em banks

However, much of the deterioration in EM BoP positions has been due to an increase in energy imports. Aside from a handful of cases such as Hungary and Turkey, where non-energy imports have also risen significantly, that reflects the increase in global prices following Russia’s invasion of Ukraine rather than overheated domestic demand. If anything, the need to finance large energy import bills is likely to have crowded out consumption of other goods.

In addition, there does not appear to be any major liquidity strains or currency mis-matches at the macro level. Short term external debts, including those of banks, are easily covered by foreign exchange reserves. Argentina and Turkey, followed by Malaysia and Hungary, appear at most risk on this metric. But these are known problems, and it is worth bearing in mind that short-term external debt has often ballooned well over 250% of foreign exchange reserves ahead of past crises.

em banks

EM banks still face a tougher period as higher interest rates hit economic growth and cause non-performing loans to rise. And a deepening of concerns over the health of the global financial system would be likely to cause volatility in EM financial markets. But relatively solid macroeconomic fundamentals mean that a raft of crises emanating from the banking sector is a fairly low probability scenario.


David Rees
Senior Emerging Markets Economist


Economic views
Emerging Markets
Central banks
Interest rates
Follow us

Please consider a fund's investment objectives, risks, charges and expenses carefully before investing.

The website and the content included is intended for US-based financial intermediaries (and their non-US affiliates) on behalf of those of their clients who are both (a) not “US persons” as that term is defined in Rule 902 under the United States Securities Act of 1933, as amended (the “1933 Act”) and (b) “non-United States persons” as that terms is defined in Rule 4.7(a)(vi) under the Commodity Exchange Act of 1936, as amended. None of the funds described herein is registered as an “investment company” as that term is defined in the United States Investment Company Act of 1940, as amended, and shares of the funds described herein have not been and will not be registered under the 1933 Act or the securities laws of any of the states of the United States. The shares may not be offered, sold or delivered directly or indirectly in the United States or for the account or benefit of any “US person.”

The information contained in this website does not constitute an offer to purchase or sell, advertise, recommend, distribute or solicit a subscription for interests in investment products in any Latin American jurisdiction where such would be unauthorized. The information contained in this website is not intended for distribution to the public in general and must not be reproduced or distributed, entirely or partially to any individuals who are not allowed to receive it according to applicable legislation. The investment products and their distribution may not be registered in Latin America, and therefore may not meet certain requirements and procedures usually observed in public offerings of securities registered in the region, with which investors in the Latin America capital markets may be familiar. For this reason, the access of the investors to certain information regarding the investment products may be restricted. Financial intermediaries and Advisors must ensure the information provided in this website is appropriate and suitable to the receiver’s domicile and jurisdiction and according to the applicable legislation.

For illustrative purposes only and does not constitute a recommendation to invest in the above-mentioned security/sector/country.

Issued by Schroder Investment Management (Europe) S.A., 5 (“SIM Europe”), rue Höhenhof, L-1736 Senningerberg, Luxembourg. Registered No. B 37.799

Schroder Investment Management North America Inc. (“SIMNA”) is an SEC registered investment adviser, CRD Number 105820, providing asset management products and services to clients in the US and registered as a Portfolio Manager with the securities regulatory authorities in Canada.  Schroder Fund Advisors LLC (“SFA”) is a wholly-owned subsidiary of SIMNA Inc. and is registered as a limited purpose broker-dealer with FINRA and as an Exempt Market Dealer with the securities regulatory authorities in Canada.  SFA markets certain investment vehicles for which other Schroders entities are investment advisers.

Schroders Capital is the private markets investment division of Schroders plc.  Schroders Capital Management (US) Inc. (“Schroders Capital US”) is registered as an investment adviser with the US Securities and Exchange Commission (SEC).  It provides asset management products and services to clients in the United States and Canada.  For more information, visit

SIM (Europe), SIMNA, SFA and Schroders Capital are wholly owned subsidiaries of Schroders plc.