Is EU monetary policy finally creating some momentum in the real economy, as banks near deleveraging targets and start once again to focus on loan growth?
Hard to say in absolute terms, but the results of the ECB’s January 2016 euro area bank lending survey, out Tuesday, reveal a couple of things.
Firstly, against a backdrop of worsening access by banks to money-market and debt funding in Q4, net credit standards on loans eased, both to enterprises and to households for house purchases. This was largely driven by competitive pressures on both counts; but banks’ stronger capital positions and a reduction in riskier RWAs also helped.
Secondly, there was higher net demand for loans, especially from enterprises, driven by the generally low level of interest rates but also crucially because demand for working capital and fixed investment were stronger. Increased demand is clearly a good sign, given that the fall-off in lending had been linked for some time as much, if not more, to poor demand as a lack of supply, while debtors did everything they could to pay off outstanding facilities.
Either way, the ECB data suggest a recovery in loan growth, particularly for enterprises. But what form, I ask, might this recovery in demand take? If banks are in better shape from a capital and balance sheet perspective, will the slow process of disintermediation in Europe continue? Or will it be stopped in its tracks as banks push out better terms and show themselves to be open for business, and frankly much better suited than bond investors to lend to the large swathe of European SMEs?
Even though absolute bond yields remain low, credit spreads have been volatile and have moved broadly wider. The better risk-reward may have put a lot of credit investors back on-side again, particularly at the riskier end of the credit spectrum. But I wonder if the current bond market environment is being seen as an attractive place for debut issuers or fledgling borrowers considering expanding their debt financing options.
Dealing with NPLs
A huge swing factor in this whole debate will be how European banks assess asset quality and deal with the thorny issue of non-performing loans. The quantum of NPLs in the European banking sector is huge – around €800bn-€825bn at SSM-supervised banks – and banks, broadly speaking, have been engaged for far too long in the ‘pretend-and-extend’ game or have buried their heads in the sand over NPL recognition, coverage (only about 43% of NPLs are provisioned for), collateral valuation (way too high in many cases) and write-offs (impact on solvency and profitability).
Convoluted bankruptcy regimes in some EU countries means foreclosure and asset recovery remain cumbersome. Portfolio offload mechanisms are slow and haven’t really scratched the surface, despite strong reported interest from distressed funds. Non-performing loans are estimated at close to 6% of total loans and advances, or 10% for exposures to non-financial corporates (SMEs). NPL distribution shows smaller EU banks have real problems – an 18% ratio against 9% for medium-sized banks and 4% for larger institutions.
NPLs didn’t make it as a separate topic into the ECB’s supervision priorities for 2016. Business model and profitability risk ranks highest in that regard, followed by credit risk; capital adequacy; risk governance and data quality; and liquidity. But the ECB has set up an NPL task force and news this weekend that it is taking a particular interest in the NPL situation at certain banks caused a sharp intake of breath Monday, and some European banks saw their share prices hammered (particularly Italian banks).
European and national supervisors can probably do a lot more to bring the subject to the fore and force the issue with banks: There’s the ‘carrot’ of better tax treatment for specific loan-loss provisions; or the ‘stick’ of higher capital requirements for loans long past-due, capital that could, of course, be utilised far more productively in the form of new lending.
In short, there are signs of recovery out there among lenders but I’m hedging this one. As my title suggests, we might not be able to see the light at the end of the tunnel yet, but the tunnel could slowly be coming into focus.
