For weeks, Asian banks and businesses have seen their borrowing costs climb as cash-strapped European banks repatriate funds and cut back on loans, knowing full well this is merely a down-payment on a long and painful shrinking of funding markets.
The impact so far of the euro zone's messy debt crisis has been in the weakest points in Asia: India and South Korea, whose banks rely heavily on foreign funding; Indonesia, where foreigners hold a large chunk of high-yielding bonds; and wholesale syndicated loan markets, where borrowers are looking to raise long-term funds from risk-averse investors.
Yet tell-tale signs of how much more pain is in store are there, both anecdotally in credit markets as well as in the steadily rising swap spreads, reduced volumes, higher currency forwards and heavier central bank interventions.
We're in the first innings as far as European bank deleveraging goes, said Krishna Hegde, credit strategist at Barclays Capital.
European banks traditionally have been active in syndicated loans and trade finance in Asia, he said, adding those banks which were typically buyers of assets have turned sellers.
Depending on how the European sovereign situation evolves, we could see more pressure going forward. The amount of assets that need to be worked down is potentially very large, said Hegde.
With an estimated $1.6 trillion of exposure to Asia, not including lending in money markets, a full-scale retreat by banks from continental Europe could lead to a liquidity squeeze like that seen in late 2008.
Access to much-sought-after dollar funding has been tight. Even relatively healthy banks, such as those in Australia, have seen costs rise as investors everywhere become reluctant to lend to any institution except at penurious rates.
For instance, the cost of swapping the yen for dollars via basis swaps now hovering near the highest levels since the global financial crisis. One explanation for that sort of pressure in an otherwise extremely liquid Japanese money market is that European banks and borrowers are seeking dollar funds in markets beyond their shores, and cheaply.
The 1-year dollar/yen cross currency basis swaps widened to minus 77 basis points at one point last week, the widest since October 2008, and were near minus 74 basis points on Thursday.
The Indian rupee has been driven to record lows by worry that the volatile portfolio flows funding the economy's massive current account deficit will evaporate swiftly. Indian banks are borrowing huge amounts each day from a central bank repo window.
Indonesia's central bank has offered dollars in exchange for its rupiah bonds, just to prevent a rush from its market into a safe-haven asset.
So far, the pullback has not been anything as disorderly as in the last global financial crisis.
True, exporters are having to pay as much as 100-200 basis points more for trade finance, a traditional stronghold of the European banks. But the money hasn't dried up, nor has there been any unusual decrease in shipping or freight activity, as was the case immediately after Lehman collapsed in 2008.
Data from the Bank of Korea on Wednesday showed short-term external debt fell 10 percent in the third quarter alone, to $138.5 billion. Most of the drop came from foreign bank branches in the country, leading analysts to suspect this is owing to deleveraging by Europe.
Two of Australia's biggest banks have postponed plans to launch bond issues because the costs were too great, even though the bonds were of a type normally considered super-safe.
That has fed concerns that rising funding costs could prompt the banks to nudge up rates for domestic borrowers.
A borrower in Hong Kong, IFC Development -- a joint venture between blue chips Sun Hung Properties <0016.HK>, Henderson Land Development Co <0012.HK> and Hong Kong & China Gas Co -- initially planned on raising a HK$17 billion loan. That was cut to HK$10 billion in August and then halved last month. Pricing was increased to 175 basis points over the Hong Kong interbank rate from 140-150 basis points.
There have also been signs European lenders are retreating from Australia's A$65 billion syndicated loan market. Names such as BNP Paribas
The banks were mainly selling project finance loans, such as Bank of Ireland's sale of its A$300 million portfolio earlier this month.
Then again, Australian banks have been only too happy to relieve the Europeans of their loans, an opportunity likely to be taken by many of the healthier banks in the Asia region. China's ICBC <601398.SS>, the world's largest bank, is eyeing assets that some European lenders are looking to shed.
We are in a position to take on some of these assets, Han Ruixiang, head of ICBC Australia, told a business lunch in Melbourne. ICBC entered Australia in 2008 and built its asset base partly by snapping up assets from European banks that were exiting the market during the global financial crisis.
We came at the time when they decided to leave, so we had a good time of cherry-picking in 2009 and 2010, Han said.
European banks had $1.6 trillion total exposure to Asia ex-Japan as of June, according to Morgan Stanley calculations based on data reported by banks to the Bank for International Settlements (BIS). Of that, $1.4 trillion related to on-balance sheet exposures, the rest was due to off-balance sheet exposures that include derivatives, guarantees and credit commitments.
Quite possibly, judging from the relatively tranquil markets, a lot of that money hasn't left Asia.
It's also not unreasonable to assume that Europe's crisis will run deep, and that its banks will have to slowly deleverage: i.e. exit trade finance, sell their syndicated loans, and ultimately sell lease assets or parts of their business.
The first to be recalled would be deposits placed with banks in Asia, and portfolio investments.
That renders Asia's financial centers Singapore and Hong Kong, and even South Korea, vulnerable, exposing their banks to a larger loan book than is prudent. Indonesia, where foreigners own more than 30 percent of the rupiah bond market, is another weak spot.
The withdrawal of European cash could stretch those who need to fund current account deficits -- the likes of India -- while pushing up the cost of capital across the board.
Ultimately, credit analysts suspect, the European entities could even be forced to offload stakes they hold in lenders such as South Korea's Shinhan <055550.KS> or India's Yes Bank
(Additional reporting by Denny Thomas and Prakash Chakravarti in HONG KONG, Saeed Azhar, Masayuki Kitano and Ramya Venugopal in SINGAPORE; Editing by Ian Geoghegan)