Late last year, “credit conditions [in Europe] were in danger of repeating what we saw in 2007 and 2008, when the banking sector effectively shut down”, says David Owen of Jefferies. The European Central Bank (ECB) injected around €1trn into the banking system through its low-cost, three-year loans. But this merely alleviated rather than ended the European credit squeeze.
The latest survey by the ECB found that credit conditions are still tightening, albeit at a slower rate than before the emergency cash reached the system. Loans to the private sector fell for the second successive month in March. A small majority of banks intend to tighten their loan criteria further in the second quarter. The renewed recession in Europe also appears to be undermining demand for loans, which has dropped sharply.
A problem is that European banks are still leveraged and inclined to shrink their balance sheets, which they’re being forced to do anyway by new capital requirements. As raising capital in the markets is still difficult, the best way to reach the new capital targets (where capital must be 9% of total assets) is to shrink balance sheets, which implies ditching holdings or cutting lending.
The International Monetary Fund reckons banks could slash their balance sheets by €2.6trn, or 7% of assets, by 2014. Against this backdrop, the liquidity injections have barely relieved the squeeze. “Tight credit conditions,” says IHS Global Insight’s Howard Archer, “remain a serious concern for eurozone growth prospects.”