16/7/2013: Sovereign --> Private Risk Transmission

Is ECB policy too tight, about right or too loose? Well, the answer depends on many factors and metrics of choice. One metric is the cost of credit to the private sector - influenced in part by the ECB benchmark rates and in part by lending conditions and environments. The two forces are not independent of each other, however. More specifically, markets conditions (e.g. raging sovereign debt crisis in the euro area in the 2010-2011) can have impact on how monetary policy is transmitted. Put differently, in addition to banks --> sovereign transmission of risks, there is also sovereign --> private sector credit transmission mechanism.

"The Impact of the Sovereign Debt Crisis on Bank Lending Rates in the Euro Area" by Stefano Neri, June 20, 2013, Bank of Italy Occasional Paper No. 170  argues that "since the early part of 2010 tensions in the sovereign debt markets of some euro-area countries have progressively distorted monetary and credit conditions". This resulted in constriction of "the ECB monetary policy transmission mechanism and raising the cost of loans to non-financial corporations and households." The study looks at the role that the sovereign markets tensions played in determining bank lending rates in the main euro-area countries. The author finds that sovereign debt markets tensions "have had a significant impact on the cost of [private sector] credit in the peripheral countries". More specifically, "if the spreads had remained constant at the average levels recorded in April 2010, the interest rates on new loans to non-financial corporations and on residential mortgage loans to households in the peripheral countries would have been, on average, lower by 130 and 60 basis points, respectively, at the end of 2011."

Link: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2284804

Few charts, showing simulated interest rates against actual rates. Note: red lines: actual data; blue dotted lines: simulated data starting from May 2010; blue dashed lines: simulated data starting from July 2011. Percentage points.

Interest rates on new loans to non-financial corporations: counterfactual simulations - peripheral countries:

2/2/2012: Euro area credit supply remained constrained in Q4 2011

ECB's Bank Lending Survey (BLS) for January 2012 is out, showing dramatic failure of the December 2011 LTRO to kick start supply of credit to the real economy.

According to the BLS, credit standards by euro area banks tightened in the fourth quarter of 2011 on:

• loans to non-financial corporations (35% of euro area banks report tighter lending to NFCs in net terms, up from 16% in  the preceding quarter),
• loans to households for house purchase (29% of the euro area banks reporting net tightening of lending to households, up from 18% in the preceding quarter), and 
• loans for consumer credit (13%, up from 10% in the preceding quarter). 

Looking ahead, euro area banks "expect a further net tightening of credit standards, albeit at a slower pace than in the fourth quarter of 2011" in Q1 2012.  There is no easing of lending conditions on the horizon.

Overall rise in the net tightening  of credit standards was caused by:

• "the adverse combination of a weakening economic outlook" and 
• "the euro area sovereign debt crisis, which continued to undermine the banking sector’s financial position",
• In addition, "increased market scrutiny of bank solvency risks inQ4 2011 is likely to have exacerbated banks’ funding difficulties."

Euro area banks also reported a net decline in the demand for loans to NFCs in Q4 2011, albeit at  a slower pace than in the previous quarter (-5% in net terms, compared with -8% in Q3 2011).

• Banks indicated a sharp fall in the financing needs of firms for their fixed investment. 

The net demand for loans to households  declined further in Q4 2011, "broadly in line with previous expectations and with actual figures quoted in the previous survey round (-27% in the last quarter of 2011, compared with -24% in Q3 2011 for loans for house purchase, and -16% in the last quarter of 2011, compared with -15% in the third quarter for consumer credit).

For Q1 2012 banks expect a sizeable drop in the net demand for housing loans, while the decline in net demand for consumer credit is expected to remain in the same range.

Despite a massive LTRO in December 2011, "euro area banks reported a slight easing of access to wholesale funding in the last quarter of 2011, compared with replies from the previous survey,
although still a large number of euro area banks  (in net terms) continued to report significant
difficulties. ... Looking ahead, banks across the euro area overall expect some improvement  in access to wholesale market funding in the next quarter, potentially reflecting the anticipated effectiveness of non-standard measures taken by the ECB."

Banks also indicated that "sovereign market tensions led to a substantial deterioration of their funding conditions through balance sheet and liquidity management constraints, as well as through other, more indirect, channels. Banks also reported that vulnerabilities to risks stemming from the sovereign  crisis have significantly contributed to the tightening of credit standards, although some parts of the banking system were in a position to shield their lending policies from the impact of the crisis."

"...On the impact of new regulatory requirements on banks’ lending policies, banks’ replies point
to a further adjustment of risk-weighted assets and capital positions during the second half of 2011, to a larger extent than in the first half of the year and more than envisaged in July 2011. The same
applies for the impact of regulation on the net tightening of credit standards. In the coming months
banks indicate a further intensification of balance sheet adjustments and related constraints on the
bank lending channel."