When the markets finally realize the enormity of the debt problem across the world, no amount of stimulus will make much difference

The potential for additional stimulus may have distracted the markets, but it has not solved any problems. This is especially true in Europe where investors are concerned about Spanish banks. But are the real problems with the global economy limited to Europe? Or are the Spanish banks just a good example of what is soon to come?

An article about Spain published by the Financial Times in the fall of 2007 stated that there was a 21% rise in bad loans at a midsized Spanish bank, Banco Popular. The Bank of Spain wasn't concerned, because it considered Spanish banks well provisioned to sustain a two or even threefold rise in bad loans. Banco Popular provisions were 232% higher than its bad loans. Things change. While Spain's biggest banks, like Santander, BBVA and Caixabank, are in good shape, smaller regional banks, like Popular, have real issues. The recent stress test showed that Popular's bad loan provisions had been completely inadequate and that it had a €6 billion hole in its capital account.

It turns out that the problems in Spain are quite typical. Many of the larger banks in fast growing emerging markets are in relatively good shape, but the smaller banks are a mess. Like Spain, transparency is a major issue as the bad debts are either being hidden or ignored.

For example in South Korea the large banks are well capitalized and in theory unlikely to pose a systemic risk. These banks usually lend to safer, more solvent higher income customer. However there is another part of the financial system. These non banks or mutual savings institutions have grown rapidly. They specialize in lending to poorer or subprime borrowers. This lending has allowed household debt in South Korea to grow to 164% of disposable income. In the US before the crash, household debt had risen to about 120%. As the Korean economy slows, many of these debts will ultimately go bad potentially replaying the slump created by the credit card bubble that burst in 2003.

Recently a prominent Indian banker boasted that the Indian financial system was in good shape despite the down turn, because of its winning strategy of "boring banking". While this may be true of the private sector banks and the largest state banks, the smaller state owned banks are another story. In theory the level of nonperforming loans remains steady at just over 2%, but the number of 'restructured' loans has increased dramatically, over 50% by one recent estimate. State owned banks like the State Bank of India and 26 others account for 72% of total loans provided by Indian banks. They also hold 93% of the restructured loans. But 80% of these loans are held on the books of the smaller public sector banks. Many of these restructured loans were made to other public sector companies and infrastructure projects. In normal times only 15% of the restructured loans go bad, but these are not normal times. Like the Spanish banks the labelling of a loan as restructured just reduces the transparency, so it is difficult to determine the severity of the problem.

Vietnam also has a banking problem but most of its issues are apparently with the private sector banks. The state bank in Vietnam controls 70% of the market compared with only 16% for private domestic banks, but bad debts at these banks have, according to the central bank, reached alarming levels. The largest private bank, the Asia Commercial Bank, was listed in 2006. Just this month its CEO was arrested on suspicion of committing economic crimes.

Brazilian banks are having issues as well. Brazilian banks non-performing loan ratio in April 2012 was 7.9% exactly the same as Spain's average non-performing loan ratio of 7.91% reported a month earlier. After three years of deleveraging the US ratio is 4.2%. The problem is the same as Korea, massive consumer debt. Non-performing loans to consumers have risen to 8 per cent, the highest since November 2009. Consumer debt service burden is now at an unsustainable level of 24% of disposable income much higher than the 14% US consumers achieved before the 2008 collapse.

Then there is China. Certainly there is a 17% increase in bad loans for large banks like Bank of China, but at smaller banks like Ping An it is 50%. But the real problem is in the credit pyramids on everything from iron ore, to copper to cement mixers. The suppliers are selling on credit as are the buyers. Did I mention the shadow banking system?

Certainly the bad loans in Spain are severe, but the real problem has been the lack of transparency. In time the size of the problem will reveal itself in countries across the world. When the markets finally realize the real numbers, I doubt that any amount of stimulus will make much difference. 

(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages. Mr Gamble can be contacted at [email protected] or [email protected].)