ECB, BLS, TLTRO and other acronyms
Savvas Savva 13:20 - 12 May 2023
On Thursday, 4 May, the European Central Bank (ECB) proceeded to a 0.25% hike in its benchmark interest rate.
That happened despite an inflation reading in April that was higher than the month before, for the first time in 6 months (7% year-on-year). During the following week, analysts and commentators pinpointed a deciding factor in this: the Euro Area Bank Lending Survey (BLS) for the first quarter of 2023.
What the survey illustrated is primarily that the ECB’s monetary policy is working. Demand for loans saw a substantial decrease across the Euro Area, spanning enterprises, house loans and consumer credit. In housing, the decrease was similar to the one in Q4 2022, which was the highest since the beginning of the survey in 2003. The explanation by the ECB was the price of credit (interest rates), weakening housing market prospects and low consumer confidence. For companies, the decrease in borrowing demand was higher than in Q4 2022 while for consumers the decrease was less than the equivalent period.
What is more interesting than these more-or-less expected numbers is the tightening of credit standards. Credit standards are defined by the ECB as “banks’ internal guidelines or loan approval criteria” for loans and credit lines. This means, in short, that banks are making it more difficult for people and companies to borrow money, despite the higher interest rates that they can now charge.
The main reason for this is risk perceptions, according to the survey, and banks’ declining risk tolerance. Banks in the euro area are taking the prudent, risk-averse approach and prefer to deposit extra liquidity at the risk-free ECB than to lend to people and businesses for an extra margin (that has been widely compressed). This can also be topical and self-explanatory: the housing market has been on the decline, so banks stay away from house loans.
Another secondary reason is liquidity constraints. The terms for Targeted Longer-Term Refinancing Operations (TLTROs), which have been a cheap liquidity source for banks for years, have worsened. Added to that, their maturities are fast approaching, meaning that the banks will need to use their liquidity to repay them.
The repercussions of these are many but we will focus on two. Firstly, the 0.25% increment in the ECB rate is unlikely to have a massive impact on housing demand going forward, compared to its accumulated of moving from -0.5% to 3%, since it is already very subdued. On credit standards, we believe that it could lead to further tightening as it will act as further disincentive for banks to increase lending since their carry trade (attract deposits from customers and deposit at the ECB) is making more money.
Secondly, banks will most likely continue to be extraordinarily profitable for the quarters to come with their non-performing loans and costs of risk remaining in check. Having such high credit standards (the highest since the eurozone crisis in 2011) will be the most important determinant of the second part. This last point is again a bullish development in banks’ fundamentals for the next quarters that will be sustained while interest rates are healthily above zero.
Savvas Savva, Chief Investment Officer, Equine Capital Partners