The concern about the economic outlook for the Eurozone is increasing, and with good reason. At the European Central Bank (ECB), these developments are also on the agenda at the council meetings, as one can see from the minutes (the ECB calls them “Accounts”). However, it is quite interesting that the ECB points-out that growth in the Eurozone is under pressure due to the global economic headwind, especially in China and the US. When the Chairman of the US Federal Reserve Bank talks about the economic outlook in the United States, he points out that the American economy is basically healthy, though the economic problems in Europe and China are causing challenges in the US- the two central bank heads have something to talk about next time they meet for coffee.
In my opinion, the heaviest problem is centred on the Eurozone. As graphic one shows, the lending to businesses has decreased since last August, which I interpret as a clear crisis sign. This has also been recognized by the ECB, and the central bank has already announced that they will launch a TLTRO III program (Targeted Longer-Term Refinancing Operations), following the prior I and II. This is a medium-term financing option for banks in the Eurozone, where the loan capital is included in the banks’ solvency calculation. The hope is that the improved solvency will give the banks continued appetite for providing funding to, for example, the corporate sector.
This is also a good official explanation for this monetary instrument, and since the introduction of program I, it has no doubt, contributed to better credit conditions for the corporate sector in the Eurozone. At least companies with a good credit score have not been hurt by the lack of funding, because the house bank was in such a bad shape to find financing itself.
The majority of the TLTRO funding has primarily been channelled to French, Italian and Spanish banks (graphic two), who, 10 years after the global financial crisis, are still dominated by a banking sector with weak balances and lax earnings.
Out of the significant economies in the Eurozone, Italy is the weakest link in the chain, and perhaps therefore the largest consumer of TLTRO. For the same reason, Italy is an excellent case for assessing TLTRO when looking at the beneficial effect of the medicine for economic growth.
As mentioned, TLTRO has surely contributed to lending to the private sector, however, Italian banks have taken almost 35 pct. of the TLTRO funding, which is remarkable. From November 2011 until January 2019, the total bank lending to the private sector in Italy has fallen from EUR 915 billion to EUR 679 billion, which does not correspond to the large Italian appetite for the TLTRO medicine.
Against this overall picture, one can come up with a number of corrections of explanations. Like the whole private sector lending covers more than just lending to corporations, but many households in Italy are not in such a bad shape that they can’t borrow money. This means that households’ share of borrowing has not collapsed altogether, and therefore not an explanation for the decline.
If one observes the lending trend last year in Italy, which shows a decline, one can draw a parallel to some of the TLTRO funding trances that now has a maturity of less than 12 months. With a maturity below 12 months, TLTRO changes character in the banks’ balance sheets when calculating the solvency and reserve requirements. One could argue that this is an argument for a reduced lending activity by the banks last year, and it certainly can be a minor explanation behind the decrease in the lending provided by the banks. Undoubtedly, TLTRO has made it possible for a number of Southern European banks to maintain lending that the banks otherwise would have had to reject, due to their own weak balances (i.e. solvency problems).
In my opinion, it reaffirms that the TLTRO programs have helped healthy companies to finance their existing business. But TLTRO has not created any additional venture capital from the banks that will translate into new GDP growth- also here, Italy is a prime example.
My assessment is that banks’ lending to the private sector reflects the level of economic activity in the respective countries, but the lending is not further encouraged by, for example, ECB’s TLTRO program.
Therefore, my assessment about the monetary actions that the ECB will announce during this second quarter, presumably in June, is quite clear. It might all sound very exciting, and after the announcements, the euro can even jump a percent or so, and the stock markets might turn euphoric for an afternoon, though that should be it.
The TLTRO medicine will very likely be consumed as it is today, and I would not be surprised if the Italian banks primarily invest the funds in Italian government bonds. Thus, the ECB indirectly finances the growing budget deficit in Italy, and the southern European banks are kept floating with capital from the ECB.
The official explanation that TLTRO is to secure sufficient lending to the private sector is probably well-meaning and makes some sense. However, my opinion is that a number of Southern European banks have become dependent on TLTRO, which leads them to a lazy life with a low return on equity – this is worrying in itself, because the banking sector never gets healthy, and neither will it make it attractive to investors.