Overdrawn: bailing out Argentina's government will cost the banks--and the country, too. (Banking).

Argentina's long, slow and ultimately predictable decline has nonetheless produced a serious shockwave for its foreign-dominated banking sector. Devaluation overnight chopped assets of US$141 billion in half. Another $30 billion in bad public-sector bonds means many banks might have to pack up and leave Argentina for good.

Big banks that lent heavily to the government, including HSBC and BankBoston, are likely to leave first, analysts say. HSBC said publicly it might go following a $1.1 billion charge on its Argentine holding company. Less inclined to bail are Spanish-owned powerhouses Banco Rio de la Plata and BBVA Banco Frances, because of the impact their departures could have on their prestige elsewhere--although no one can rule out their exit, too, if things get ugly enough.

At press time, an Argentine judge had slapped a foreign travel ban on executives at several top international banks, including Citibank, Italian-controlled Banque Sudameris, Banco Galicia, BankBoston and Canada's Bank of Nova Scotia, as an investigation began into millions of dollars in capital flight at about the time Argentina's currency crashed. The government also announced plans to begin letting banks fail by April 15 as the IMF dragged its feet on a bailout.

"Argentina's crisis will really be a watershed event for global banks," says Robert Lacoursiere, director of Latin American equity research for Lehman Brothers in New York. "It'll separate those who truly want to pursue a Latin American strategy from those who've just been tinkering."

For much of the past decade, loaning to the government was the best business in town. Charging rates as high as 15% in dollars for 90-day bonds, local branches and subsidiaries of foreign banks could make the sort of quick, juicy turnaround of which their overseers in the United States and Europe could only dream. Of less importance was a ballooning public debt that consumed 40% of the federal government's budget and hobbled the country's ability to end more than three painful years of recession.

In the end, the bubble burst. "After a decade of thinking Argentina was the golden child of emerging markets, investors and banks are waking up to the fact that it was the black hole," says Christian Stracke, strategist for Commerzbank Securities in New York.

The banks face conversion of their U.S. dollar loans into pesos at a less favorable exchange rate than they must pay to their dollar depositors, a regime that will make it impossible to stay solvent. The government has promised to issue a peso bond to pay the expected $20 billion price tag for the mismatch. Savers will have a choice between withdrawing their funds--eventually--or taking government bonds.

Quicksand. Problem is, nobody believes the government's IOU will be repaid. Deep-pocketed foreign banks that dominate 70% of Argentina's banking system might still have to ante up the $20 billion to $23 billion a bailout could cost. "The truth is no bank really knows where they stand right now," says Hernan Bullrich, of Alchemy Asset Management in Buenos Aires. "But the earth they all walk on suddenly feels a lot like quicksand."

It could take more than a decade before deposits return to levels reached in 1999, when deposits and circulating currency peaked at 37% of gross domestic product. Instead, they're likely to slip closer to the 3% to 5% levels seen during the chaotic hyperinflation of the late 1980s, when economic activity was mostly in cash.

It's easy to underestimate the costs of leaving for foreign banks. Central bankers have long memories. An exodus now sends a strong message to other countries: When times are tough, loyalty is thin.

Depositors will be hard to win back, too. "Once you've broken such a fundamental institution like someone's rights to savings, no amount of sound economic policy can regain their trust," says Abel Viglione, senior economist at domestic think tank Fiel. "It'll take along, long time before the pendulum swings back, if it ever does."

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