Scott Martin: Despite fretting about trouble in Europe spreading to Brazil’s (NYSE:EWZ) financial system, exposure to the troubled markets of Spain and Portugal seems minimal at best for South America’s biggest country.

In fact, the Brazilian central bank just ran a new series of stress tests and discovered that the country’s leading financial institutions have no appreciable vulnerability to a sovereign default — unlike their peers in France and elsewhere in the euro zone.

And domestic credit quality at institutions such as Bradesco (NYSE:BBD) seems to be improving.

This flies in the face of arguments that if Europe’s leading banks are sick, their counterparts in emerging markets must be in extremely bad shape.

The fact is, Brazil’s banks have been holding up remarkably well.

There have been disappointments at Itau (NYSE:ITUB) and Santander (NYSE:BSBR), but on the whole, trader nightmares about a U.S.-style credit-market crash have not materialized.

November’s bailout of troubled lender Panamericano now looks isolated, and in the meantime, local credit-card interest rates at more than 170% have ensured that Brazil’s banks can generate the income to cover their losses.

Still, these stocks have taken a back seat to banks elsewhere in the emerging world, notably China, where lenders arguably face bigger — but less-publicized — problems.

While shares of Itau, Bradesco and Santander have handily outperformed their euro zone peers — as embodied in EUFN, the European financial sector ETF — they have also lagged EMFN, the emerging markets financial sector ETF:

Credit quality and exposure to Europe have generally been cited as the drivers of that underperformance. If foreign and domestic loan portfolios are actually in better shape than traders suspect, these stocks could be due a second look.

Some say Brazil remains hostage to the news from Europe, with the Bovespa index down 22% this year and the real currency falling 13% against the dollar in the last month. With the August cut in interest rates, the economy may be set up for a shock that will never come.

“No matter how oversold it may seem, I am not touching Brazilian stocks or the Brazilian real until Europe either blows up or the problems there are resolved,” a US-based fund manager told the Financial Times.

With inflation running at more than 7%, and a growing economy, investors fear the rate cut will add fuel to Brazil’s inflationary fire, if Europe fails to crash and deliver a shock to the global economy.

Written By Scott Martin From Emerging Money

Emerging Money provides insightful and timely information about the increasingly important world of Emerging Market investments. CNBC Emerging Markets Contributor Tim Seymour leads the team of Emerging Money to bring you cutting edge global news and analysis.

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NASDAQ:EMFN, NASDAQ:EUFN, NYSE:EWZ