The euro dropped sharply against the dollar on Friday morning, following reports that the European Central Bank (ECB) is concerned over the impact of a weak Turkish lira on European banks.
The euro also fell 0.5 percent to trade at $1.146 in the early hours of Friday. This followed a report by the Financial Times that Spain’s BBVA, Italy’s UniCredit, and France’s BNP Paribas could be particularly impacted by the ongoing depreciation of the lira.
Over the last year, the Turkish currency has lost about 33 percent of its value on the back of large fiscal stimulus, growing inflation and current account deficit, as well as intervention from President Erdogan on central bank policy decisions.
Lira’s depreciation could dent European banks that have invested in Turkey. According to the report, the ECB is particularly concerned that Turkish citizens might not be prepared to support the depreciation of the lira and will start defaulting on foreign-currency loans. These represent about 40 percent of the total assets in the Turkish banking sector.
Data from the Bank for International Settlements (BIS) showed that Spanish banks are due $83.3 billion by Turkish borrowers; French lenders are owed $38.4 billion; and banks in Italy are owed $17 billion, the FT reported.
Meanwhile, the cost of insuring exposure to Turkish debt rose on Thursday to the highest level since 2009. Turkey’s five-year credit default swaps rose to 379 basis points, hitting the highest since April 2009.
“Of course, a full blown Turkish banking crisis would have some negative repercussions on euro zone banks that have large credit exposure to Turkey or own Turkish banks. But overall, the euro zone banking exposure seems too small to cause a significant crisis,” Carsten Hesse, European economist at Berenberg bank said in a note to clients Friday morning.
“But even if we are wrong and a potential meltdown of the Turkish banking sector would cause serious trouble for some euro zone banks, bank supervisors in the region would have sufficient tools at their disposal to contain the damage. That the fallout from Turkey could cause any credit crunch in any part of the euro zone seems highly unlikely,” he said.