The Eurozone banking system has been subject to lending restrictions even before the latest financial turbulence was triggered by the pandemic crisis in 2020. This article discusses why the lending process in the Eurozone has been hindered and why banks have been extremely pruned when it comes to credit extension. Additionally, this article offers insight into what the current lending reality looks like in the Eurozone today and how it could shape the Eurozone’s future.
Background to Eurozone Banks Cutting Lending
The euro crisis has certainly been a contributing factor in the Eurozone banks’ credit-tightening approach in recent years. It was during this period that the governments of several Eurozone countries had to be bailed out, along with their banks, which resulted in a significant contraction of credit and lending in the Eurozone.
However, since the end of the euro crisis, Eurozone banks have not been quick to recover and open up the lending process. Bank lending in the Eurozone has stayed low in comparison to banks in other countries around the world. This is due to a number of factors that are specific to the Eurozone economy, both before and after the euro crisis.
Regulatory Tension and Its Impacts
The Eurozone is subject to stricter regulatory pressures compared to many other countries or regions. This was already apparent before the financial turmoil started in 2020, particularly with the EU’s Capital Requirements Directive (CRD). These regulations and pressure from the European Central Bank (ECB) and EU have made it difficult for banks to open up their lending portfolios.
The regulations and their compliance requirements impose an extra burden on banks that makes it harder to approve and move forward with potential deals and customers. Additionally, the necessity to comply with EU standards for Pillar II capital requirements mean that banks need more capital to back up their lending operations. Banks have often had to hold extra capital and increase their total capital ratio in order to be able to lend. This has meant that, rather than expand their loan books, banks have had to focus on creating a safe, secure solvent position by reigning in their lending portfolios.
Structural Barriers to Lending
The Eurozone banking system was in significant trouble prior to the financial crisis. Banks struggled with bad loans, high non-performing loan ratios, and lending challenges. These challenges have been compounded further by the financial crisis, making them even more reluctant to lend, even if they have the capability to do so. This is due to a number of structural challenges, both external and internal in the Eurozone economy.
One of the main structural challenges in the Eurozone economy is the high capital requirements from banks. Banks who meet the stringent capital requirements of the ECB and other EU regulatory authorities often need to hold a large amount of capital to cover their loanbook and make them more secure. Thishas placed major constraints on lending in the Eurozone, stifling growth and progress.
Another structural issue in the Eurozone is the fragmented and fragmented banking system. Each bank is responsible for its own risk management, which can often be a difficult process. There have also been difficulties in creating common banking standards, which makes it harder to operate as a unified force in terms of lending. In other words, the Eurozone structure has posed a challenge to creating a simplified, efficient, consistent and fair lending regime.
Another issue is that the ECB and EU have been trying to increase the amount of non-performing loans (NPLs). This has been done in an effort to address the banking crisis, but it has also had an impact on the ability of Eurozone banks to lend. Banks are now stricter on who they are willing to lend to and more likely to reject applications in order to avoid building their NPL portfolios.
Finally, another considerable barrier to lending in the Eurozone is the lingering debt crisis. There are still countries such as Greece, Italy, Portugal and Spain that are struggling with their debt burdens, leading to investor uncertainty and reduced lending. This has caused banks to remain cautious in terms of how much they are willing to lend.
Signs of an Upturn in Lending
Despite the challenges felt throughout the Eurozone lending industry, there are still some signs of growth and hope in the system. In recent months, there have been some positive moves towards a healthier lending system in the Eurozone.
For instance, the ECB has recently introduced its Targeted Longer-Term Refinancing Operations (TLTRO) program. The aim of this program is to incentivize banks to lend money to companies and households, as well as to make credit easier to obtain. This has been further bolstered by the reinforcement of the Single Supervisory Mechanism (SSM), which has been put in place to ensure more consistent and better levels of bank supervision.
In addition, the EU has also taken steps to tackle the NPL problem. In December 2019, the European Commission’s Bank Recovery and Resolution Directive (BRRD) was enhanced, making it easier for banks to write down bad loans and move them away from their balance sheet. This has gone some way towards helping banks to improve their lending environment.
Additionally, the European Central Bank introduced its bank lending survey during 2020. This survey is used to understand the current state of lending across the Eurozone. The survey’s results have suggested that, while banks remain cautious when it comes to lending, they are starting to slowly show a willingness to lend.
The Eurozone’s banking system has been subject to various restrictions when it comes to lending even before the global pandemic-induced financial turmoil of 2020. Bank’s have had to become extremely conservative when it comes to credit extension due to a number of different issues, both external and internal.
However, despite the current economic context, there are already signs of improvement in terms of the Eurozone’s lending environment. Several initiatives have been put in place by the ECB and European Commission which should ease the credit extension process and enable Eurozone banks to open up more to their customers.
In many ways, the Eurozone’s lending environment remains fragile and uncertain; however, with the aforementioned steps being taken by the respective authorities, there is good cause for optimism. Although the future of lending in the Eurozone remains uncertain, it appears that the circumstances and measures that have been taken will point towards a move towards a healthier and more dynamic lending system.