Earlier this week the European Central Bank (ECB) released the results of its quarterly Bank Lending Survey (BLS). Although this publication was hardly mentioned by media and market commentaries it is an important leading indicator in my opinion as the trends in lending activity are undoubtedly one of the main drivers of economic growth.

I would go one step further. These trends serve to assess whether the money printing programme on which the ECB embarked upon will go beyond inflating equity and bond prices and feed into the real economy. The main channel which would allow this to happen is increased credit activity and to illustrate the importance of credit growth we only have to look back to 2012 when the ECB’s balance sheet reached record highs following large and cheap credit extended to European banks. These measures, in effect just another form of money printing, did little to kick-start lending or re-ignite inflation because banks kept the extra liquidity or used it to purchase government bonds.

Will the same happen this time round? I have long been of the opinion that this might indeed be the case in the weaker economies where business confidence has been undermined by political and structural factors. However, seeing the latest BLS results I must admit there is room for hope.

The March survey showed that banks further eased their credit standards for enterprises (i.e. granted loans more easily) and that the changes were much stronger than banks had anticipated in the previous survey. The credit institutions also replied that further easing is anticipating over the next three months. To put these results in context, the easing in credit standards started off in Q2 2014 but notwithstanding the improvements reported since then we are far off from reaching normal conditions.

I would also highlight that Italian banks reported a significant easing of credit standards, an important step forward for a country which has been experiencing a sizable contraction in lending; the main driver was apparently changes in “risk perceptions”. For Spain the results were mixed as credit standards were almost unchanged but a sizable improvement in terms and conditions (mainly interest rates).

The report adds  “Among the factors affecting banks’ credit standards, in particular banks’ cost of funds and balance sheet constraints and competition were driving banks’ further easing of credit standards for loans to enterprises. Banks’ risk tolerance – a factor which has been introduced in this survey round – also contributed marginally to the net easing, whereas banks’ risk perception had a neutral impact on credit standards on loans to enterprises”.

On the demand side, banks continued to see a growth in demand over the first quarter mainly due to the “general level of interest rates”. Meanwhile, “fixed investment contributed negatively or neutrally to loan demand, with the exception of Spain” which speaks of excess capacity and/or low business confidence.

For mortgages, demand increased due to the low interest levels but banks have tightened their requirements and plan to do the same over Q2. For consumer credit, demand strengthened as well and banks eased their requirements.

Another interesting finding from the BLS regards the effects of the bond-buying (QE or APP) programme. The respondents indicated that they used the extra liquidity mainly for lending and that over the second quarter such allocations should increase. What is more, the survey found that banks expect a “decline of their holdings of euro area sovereign bonds over the next six months” which could serve to alleviate speculations that ECB will struggle to find sellers.

From the same report we quote “Nearly half of the euro area banks (net percentage of 47 per cent) reported a positive impact of the APP on their market financing conditions, in particular for their financing via covered bonds and unsecured bank bonds, in line with banks’ considerably further improved access to debt securities financing. For the banks with asset-backed securities (ABS) business (about 50% of the euro area banks in the BLS sample), also this financing source improved considerably. Banks (in net terms 42 per cent) expect an ongoing improvement of their market financing conditions related to the APP also for the next six months.”

Finally, the banks reckoned that the decline in yields will lower their interest margins but they expect capital gains on their securities portfolio to offset this. As such, QE is expected to have a positive effect on profits, capital and leverage. 

So where does this leave us? Should the findings of this report translate in increased lending in the following months we are due to see a stabilization of the European economy and a pickup in inflation expectations. This should support equities and high yield bonds but might act as a headwind for investment grade bonds.

In my opinion it is too soon to draw a conclusion. The developments in the peripheral countries are of particular importance as lending to corporates here has been declining fast. Relatedly, I am worried that lending might suffer following the recent noise around the deferred tax assets (basically tax assets carried foreword to be recognised when profits are stronger) recognised by Italian and Spanish banks as part of their capital ratios (despite the Basel III recommendations not to do so).

Disclaimer:

This article was issued by Raluca Filip, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri & Co. Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.