Exposure to foreign markets makes ANZ riskier than the Commonwealth Bank of Australia

Which bank shares are the safest?

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Clancy Yates recently reported in the Sydney Morning Herald that there has been a sharp increase in Australian banks' lending to China. Indeed, the value of Chinese loans on the books more than doubled in the year to September 2013, to over $32 billion.

The recent currency devaluation in various emerging markets should have investors thinking carefully about foreign exposure. They should also pay attention to George Soros's concerns about the future direction of China. A report by Credit Suisse identifies Australia and New Zealand Banking Group (ASX: ANZ) as having the highest overseas exposure, at 32%, followed by National Australia Bank Ltd. (ASX: NAB) at about 25%.

In contrast, only about 12% of the loans of Commonwealth Bank of Australia (ASX: CBA) and Westpac Banking Corp (ASX: WBC) are to foreign borrowers. However, one important feature of those two banks is the high proportion of residential mortgage lending on their books. As I wrote in this article, banks are gradually increasing the loan to value ratio for mortgages. This exposes the banks to property price falls, though in my opinion, the exposure is currently acceptable.

For this reason, I'd prefer to buy Commonwealth Bank or Westpac shares to NAB or ANZ shares. Indeed, NAB has consistently made losses on its UK business, so I'm not excited about Aussie banks' overseas expansion over the next decade. Citi analyst Crag Williams summed it up nicely when he said: "With over 20 years in the UK, and still only a modest regional presence, we have not seen any significant ROE impact arising from technological, product or knowledge transfer from NAB to this [UK] business."

While ANZ does seem to be growing its Asian business nicely, as the company expands, it becomes increasingly difficult to understand the risks involved. It's hard enough to understand economic conditions in one country, let alone several. However, investors should be mindful of the fact that economies do have crises, and banks' shareholders do not always emerge unscathed, as they have done in Australia, post-2009. For example, long-term investors in Bank of America Corp (NYSE: BAC) are down over 50% (accounting for dividends) in the near-decade since the share-split in 2004.

Foolish takeaway

I don't own any big bank shares because I don't think they trade at attractive prices. In part, that could be because SMSF investors love dividend-paying companies they can recognise, none more so than the banks. Furthermore, many analysts cover the big banks, so the potential for mispricing is lower than for small-cap companies. I agree with Motley Fool analyst Mike King that the SMSF property bubble is a myth, so I wouldn't be overly concerned with bank exposure to mortgage lending, although that is still a risk to watch over the long term. The recent drop in the value of the currencies of Turkey, South Africa, Argentina, Chile, and Russia has reminded me that emerging markets are not always a safe place to invest. If I did want to buy bank shares, I'd probably stick to Westpac and Commonwealth Bank, although I don't think bank shares are the best investment, at current prices.

Motley Fool contributor Claude Walker (@claudedwalker) does not own shares in any of the companies mentioned in this article.

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