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EU Banks Suffer from Low Oil Prices

European banks and their unfortunate would-be borrowers, face another blow as plunging oil prices tighten the spigot of petrodollar deposits

Banks in Europe, and their unfortunate would-be borrowers, face another blow as plunging oil prices tighten the spigot of petrodollar deposits.

Billions of dollars' worth of funds from oil-exporting nations have made their way into banks from Zurich to London in recent years. These inflows helped banks withstand credit crisis losses and, given that much of the money was in dollars, were a source of dollar liquidity during recent money market difficulties.

Petrodollars also arguably fed the lending boom while it lasted and cushioned the effects when the boom turned to bust. But with oil having tumbled to around $55 a barrel from almost $150 this summer and the mid-$90s a year ago, flows into European banks will most likely drop dramatically. What's more, a global recession and rolling financial crises mean that oil producers like Russia and the Middle East states will have new calls to spend money at home, further diminishing the money available to grease the wheels of international banking.

Though it is impossible to track exactly, depositors from oil- exporting states have long shown a preference for British and European banks over U.S. ones, some for political reasons, like Venezuela, and some out of concern over the effects of U.S. banking disclosure laws passed after the terrorist attacks of Sept. 11, 2001.

This, needless to say, is not a good time for these banks to lose an important source of inflows. It will worsen their position and make it tougher for their clients to secure loans.

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Borrowers in emerging European countries, like Hungary, may be particularly hard hit, having gorged on credit during the boom.

Deposits abroad from oil-producing countries hit more than $1.2 trillion at the end of 2007, according to the most recent figures from the Bank for International Settlements, up from less than half a trillion in the third quarter of 2003. More than $150 billion flowed into international accounts in 2007 alone, according to the bank. Those flows continued to be strong in the first half of this year as oil soared, but are surely slowing now and will continue to diminish as long as oil and the global economy struggle.

Certainly the oil-producing states have new calls on their funds. The Gulf is particularly suffering from crashing confidence and tight liquidity and has its own housing boom turning to dust. The United Arab Emirates poured $6.8 billion into the financial system in October as part of a $19.1 billion rescue facility, while Saudi Arabia injected $3 billion in long-term deposits into its banks, echoing similar moves elsewhere.

Russian central bank reserves are down about $120 billion since their August peak, sapped in part by huge interventions to support the ruble.

Huge amounts of petrodollars flowed into U.S. banks during the oil price spike of the 1970s, much of which was recycled into ill-fated floating rate loans to Latin America. That ended with the Latin American crises of the 1980s, causing a series of problems that now seem familiar, including bank capital woes and the need for official intervention.

"This time around, petrodollars may have been deposited with European banks, which in turn lent aggressively to emerging market economies in all three time zones," Stephen Jen, currency strategist at Morgan Stanley in London, wrote in a note to clients. "Assuming this thesis is correct, sharply lower oil prices will constrain the recycling of petrodollars, and constrained risk-taking appetite of European banks could choke off loan flows into emerging Europe."

Jen also notes that European banks are five times more exposed to emerging markets through bank debt than their U.S. and Japanese peers.

For some countries that have benefited from petrodollar banking flows, there is another problem that their diminution will make worse; the banking sector is huge in relation to the size and wherewithal of the host economy.

Whereas bank liabilities in the United States were equal to about 20 percent of gross domestic product in 2006, the last time the Bank for International Settlements published such data, for Britain it was 285 percent and for Switzerland 317 percent.

That certainly gives things a piquancy when bank rescues are in the air.

High oil prices were a huge burden on oil consumers, and you can argue that as usual, when faced with a surfeit of cash, banks used it for trinkets and speculative loans. But a cutback in that flow of deposits is one of the last things the banks or their overburdened regulators want to see.