Can Europe’s creditless recovery continue?

Fresh from Westpac’s Elliot Clarke.

With growing concerns over deflation and very little room to move on interest rates, the May ECB meeting brought Euro Area credit trends back to the forefront of investors’ minds. As at March, total loans to the resident private sector were 2.2% lower than a year ago. This is not a one off: annual growth in total loans to the resident private sector has been negative for two years.

The disaggregated Monetary and Financial Institutions (MFI; i.e. European Banks) data for the Euro Area allows us to gain a better understanding of the underlying trends in credit provision, both with respect to the domicile of the banks writing the loans and also which sectors are putting the funds to work. (Note: unlike the reported aggregate headline, this data is not seasonally or working-day adjusted.)

The MFI data makes it clear that there has been a marked divergence in non-MFI, private-sector credit provision by country. The decline in private lending by Spanish banks has been particularly sharp and protracted, with a cumulative 24% rundown since end-2008. This is not particularly surprising given the impact the GFC and ensuing recession have had – bad loans make up over 13% of total Spanish loans. Lending by Italian and German banks has declined by a more modest (but still substantial) 4–5% from peak levels, respectively seen in 2011 and 2012. In stark contrast, French banks have continued to increase their stock of loans, with loan growth of 11% since end-2008, but nil over the past year.


The themes apparent in the sectoral detail are also salient. Starting with loans to non-financial firms, after peaking at 15%yr in April 2008, annual growth fell to –3.9%yr by the beginning of 2010. And, after a brief renaissance in 2011, credit to this sector has trended lower for the past two years. As at March 2014, loans to Euro Area non-financials were down 11% from their January 2009 peak (but still almost twice as large as at the beginning of 1999, when the Euro was fully introduced).


For households, we have seen two divergent trends in recent years for consumer credit and mortgages. Highlighting the reduced demand for durable goods, annual growth in consumer credit has been negative for almost three years, leaving the stock of consumer credit some 12% lower than its mid-2010 peak (but still 38% above it beginning-1999 level).


In contrast, but for a few very marginally negative outcomes in 2009, annual mortgage loan growth has remained positive since the GFC, leaving the total stock of mortgage credit some 11% higher than at the beginning of 2009 (and 150% higher than beginning-1999). A caveat to this observation: part of the strength in mortgage growth through 2010 and 2011 was due to Italy imposing a moratorium on mortgage payments for some borrowers. Annual growth in mortgage credit growth excluding Italy has averaged around 1.5% since the beginning of 2009, compared to 1.9% including Italy.


Turning to the financial sector (i.e. MFI lending to other financials), we note that leverage has fallen by around 17% over the past year. The country data discussed above also points to a reduction in the scale of MFI loans to other MFIs, with: France, –4%yr; Germany, –5%yr; and Spain, –20%yr. The timing of the decline is broadly coincident with the paying back of LTRO liquidity by MFIs as they readied their balance sheets for the 2014 stress tests. Arguably this is evidence of MFI’s (unsurprisingly) managing their exposure to suit what is appropriate from a profitability and regulatory perspective, regardless of the implications for aggregate financial system liquidity.


So what to make of these results? As is apparent in the level of loans outstanding relative to the start of 1999, the European economy benefitted significantly from the free availability of credit to all sectors in the lead-up to the GFC. Since this time, there has been a dramatic change of direction in the credit impulse, with the stock of all types of private-sector credit (excluding loans for house purchase) having declined substantially. It is hardly surprising then that the post-GFC recession has proved to be so protracted and that the growth of the past year has largely come as a result of external demand (and inventories in the overnight report for Q1).

So to see an enduring rebound in domestic activity, there is a real need for credit extension, most notably for non-financial corporates, which will require demand and supply to intersect far more frequently than it is at present.

This will only come with a return to positive growth in investment. With real investment comes jobs and income, both for households and the businesses themselves. Rising income makes existing liabilities less onerous and, with time, incentivises further borrowing for households and firms alike. All of the above also gives comfort to MFIs, with less-restrictive lending standards the likely result. Here then begins the justification of targeted, liquidity-oriented policy initiatives by the ECB, which we expect to see delivered at the June meeting. The specific targeting should be informed by the nature of the existing blockages/inhibitors. In this regard, the best resource (only it is still imperfect) is the ECB’s bank lending conditions survey. We will dissect this report in detail in a forthcoming edition.

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  1. Therein lies the problem. If the ECB is about to print, through which channels will the extra liquidity be distributed if the demand for credit is missing?

  2. “So what to make of these results? As is apparent in the level of loans outstanding relative to the start of 1999, the European economy benefitted significantly from the free availability of credit to all sectors in the lead-up to the GFC. … So to see an enduring rebound in domestic activity, there is a real need for credit extension, most notably for non-financial corporates, which will require demand and supply to intersect far more frequently than it is at present.”

    Seriously? So the solution to massive credit indigestion and outstanding liabilities is… more credit? People need money to pay back credit. But if the populace is up to their necks in mortgages then guess what, they have not money to spend. And one by one businesses, who depend on patronage by the populace and not overpaid economic analysts, fold. So unemployment goes up. And you get the GFC. Methinks Mr Clarke is hinting the government that the solution to their future predicament is more government insured debt. I mean, Canada is beating us so why not?

    • I agree, Jason. You said it for me. I am late to this thread.

      I think the best recovery of all would be one in which households pay off debt at the same time as credit is taken up by productive businesses, with potentially a reduction or level-pegging in total credit.

      The perennial problem is that credit growth is now ALWAYS going into zero-sum asset price inflation. It is no guide at all to “economic recovery”. It is like a wastrel upper class twit who has blown his entire inheritance already and is still borrowing to fund his wastrel habits, not to invest in anything that will turn his position around.

  3. It is aging demographics pure and simple

    And the biggest group that is adding children in Europe is Muslims…not known to be big borrowers in the way we are used to (that was not a social comment just an economic observation so please don’t get into a religious tangent or Muslim bash from that one)

    • A demographic problem certainly. Before the GFC it was widely suggested that the peak spending age in a developed society was…47. Those consumers of 2007, and all those who were then 40+ when this lot started, have passed through their peak-spending age. What we are now left with are the follow-up spenders, who are coming to market burdened with excessive mortgage, student and other assorted debt, accumulated in an age when “debt doesn’t matter! It’s just a tool to be used”. The elderly consumers have been progressively stripped of much of their discretionary spending by ‘yield compression’, so what do we have left? An ageing society of indebted young and impoverished old , and we wonder why pre 07 levels of consumption is down! Throw in lunatic house prices that remove any improvement of discretionary income as it arrives to be chewed up in interest cost..and Voilà! We have a deflationary environment. Who could ever have guessed……

      • Looks like we live in interesting times… Whoda think the ‘end of history’ hypothesis was bollocks :).

      • That’s it in a nutshell Janet. And to top it off, our government is so proud of their surplus obsession as they transfer yet more of the burden of credit/economic growth on to the consumer. After all, we have such huge capacity to absorb it.

      • Janet you’ve encapsulated the problem beautifully.

        The western world debt is now 43% larger than it was in 2008, and growing.

        The World Bank has Australia’s federal government debt at AUD$433Bn… Just in 6 years… amazing.

    • It’s also my understanding that Islam prohibits usury; thus Islamic banks who work somewhat differently to Western banks.

      • Schadenfreude

        Quotes from the late Osama bin Laden,

        — He called on Americans to “reject the immoral acts of fornication, homosexuality, intoxicants, gambling, and usury“, in an October 2002 letter —

        — Bin Laden was anti-Semitic, and delivered warnings against alleged Jewish conspiracies: “These Jews are masters of usury and leaders in treachery. They will leave you nothing, either in this world or the next —

      • @ Schadenfreude :”Bin Laden was anti-Semitic..”

        I always have a chuckle at this one.

        Bin Laden was a Muslim, which means he was himself from the Semitic group of mainly Judaic and Islamic tribes.

    • “Muslims…not known to be big borrowers in the way we are used to”

      You make an excellent observation here Andrew.

      My (limited) understanding of Muslim culture is that attitudes to lending/borrowing are quite different, due to (as others have noted) the explicit Koranic condemnation and prohibition of usury.

      [I imagine it is rather like the way that attitudes to usury — lenders and borrowers — were indirectly the most effective form of policing of the practice in pre-16th century times in the West; the social stigma of being seen as practicing usury (either as lender or borrower) served as sufficient incentive for most, excepting the most brazen, to shun it.]

      In consequence, although I understand that there are certain workarounds that are practiced, that do enable some to “gain” somewhat from lending money, more generally what we see is that borrowing will be (a) limited in size, and if not, then (b) it will take the form of shared equity-based borrowing, whereby the lender will take on equity/risk alongside the borrower. Compared to our usury-driven system, where money-creator-lenders “risk” is essentially irrelevant thanks to “financial innovation” such as LMI, CDOs, CDSs, etc, and of course, thanks to the GFC and bank bailouts, a now firmly entrenched “moral hazard”, one would presume that the total scope of lending (thus debt enslavement) in Muslim cultures will be far less.

      It’s worth noting that, like the Koran, the Christian Bible too explicitly condemns usury. Indeed, the Christ of “Christ-ianity” commands to lend to whomever asks, and to not expect to be repaid at all, not even the principal (Luke 6:30-36).

      As does Plato, in his condemnation of usury in Laws, Book V: “no one shall deposit money with another whom he does not trust as a friend, nor shall he lend money upon interest; and the borrower should be under no obligation to repay either capital or interest.

      Alas, we in the “Christian” West have long since allowed greedy, hairsplitting, dissimulating and obfuscating lawyer-usurers, both within and without the “Church”, to slowly and inexorably convince us all that a practice which all the ancients and wise men condemned as evil, and contrary to nature — including Buddha, Moses, Plato, Aristotle, Cato, Cicero, Seneca, Aquinas, Jesus and Muhammad — is actually a good thing.

    • Not sure if that’s an obvious segue, EU economy/credit and Islam? If not Islam it’s the Chinese? Older times it was the Jews?

      The real demographic issue in Europe are declining populations numerically, and qualitative issues that come with ageing, supporting health, pensions etc.., ameliorated by e.g. UK, Germany etc. by EU mobility
      amongst working age from other countries filling skills gaps and paying taxes.

      Many countries have unsustainable pension systems, brain drain etc. which politicians either ignore or younger generations are expected to carry the can to support the older generation bubble (without receiving anything as generous, if at all).

      Islam is a broad church with various sects with little in common with each other, much like Christianity. Disenengenuous to suggest ‘Islam’ is one unitary social phenomenon… especially when most don’t get chance to explain their own beliefs, but are simply told whom they are by thier own state, international media etc….. e.g. Alevi sect in Turkey, described as Islamic (Shia), but drink alcohol, women don’t wear headscarves, men/women prayer together, no mosque etc..

      In fact in the USA research has shown that ‘Moslem’ immigrants tend towards lower fertility rates and higher education attainment vs US average.

      Don’t think anyone wants to inherit a label then be stereotyped on any implicit assumptions, all the while not being asked……. (suggest read poem by Niemoller, ‘First They Came……’)

  4. Yeah that’s my understanding of Sharia finance as well – not sure how it plays out in the West

  5. But if they borrow outside of the European banking system (in some form of shadow system) that does not bode well for deflation IMO

  6. “very little room to move on interest rates” Rot!!!

    With a fiat currency, proportional mathematics and taxation laws there is always plenty of room to move on interest rates.

    You can have negative interest rates. Switzerland used impose them on foreigners to reduce the attractiveness of flooding Switzerland with often untaxed or illegal gains.

    If interest rates are 10% you can halve their cost by reducing them to 5%, if 5% they can be halved again to 2.5%, if 2.5% they can be halved again to 1.25%, if 1.25% they can be halved again to 0.75%….Each halving of the rate halves the cost of the interest bill and long term lowers the rate of the capital investment hurdle rate of return.

    If people are saving too much and rates are effectively zero bound then impose a management tax/government guarantee levy on bank deposits of say 1%, or 2% per annum, and if people still want to save, double it again.

    • interested party

      Jeeez Explorer……you will end up at the IMF if you keep thinking this way!!!!!

    • “..impose a management tax/government guarantee levy on bank deposits” and guess how much money you will have on deposit in the bank! None. Neither will I.But it doesn’t mean I won’t have savings, and it doesn’t mean I will apply them either. I may have it in cash or I may have it reluctantly in, yes, gold. But I can’t be forced to consume it. And herein lies my belief that contrary to most expectations, it won’t be inflation of any kind that spurs gold’s rise, but deflation…… Raising interest rates can force people to stop spending, but lowering them can’t force people to spend.

  7. “but still 38% above it beginning-1999 level”

    This represents inflation of 2.5%, which is around the middle of most target ranges in OECD countries.

    The real debt is about the same as 1999 levels.

    But what has happened to population since 1999?

    It has probably grown about 1% pa. In that case the real debt per capita has fallen about 15%.

    Adjusting for inflation and population growth seems to be a skill or practice missing from financial and mainstream journalism.

  8. “This will only come with a return to positive growth in investment.”

    But investment will not come until there is a prospect that additional capacity can be profitably located in a particular place.

    At present, most additional capacity is added in China because of the currency adjusted cost of wages, real estate and regulation including environmental discharges.

    When will there be additional investment in eg Portugal?

    Only when the cost of inputs (particularly unit labor costs), management and transport to markets is low enough to beat China, Vietnam or India or Eastern Europe.

    There are huge adjustments still required to wages in the periphery to make any investment in additional capacity worthwhile.

    Real estate development along coast lines for sale to wealthy foreigners from cold climes is probably the easiest place to generate employment and income, but only by surrendering more “sovereignty” and national identity.

    There is a lesson to Australia here about the decisions (or acts of omission) to allow so much of our manufacturing industry including the car industry) to unwind. While we at least can have an external adjustment based on currency making new investment potentially profitable, the real effects of extreme Dutch disease are not felt until the manufacturing base and it’s employment is decimated. The fall in the currency to make investment worthwhile is then much larger.

    • “There are huge adjustments still required to wages in the periphery..” Quite right. But it isn’t just the periphery that WILL make that adjustment. By extension, that will force all other compatible economies to follow suit – especially Australia (as the most expensive place on the planet in wages terms to do almost anything!) If you want to keep those manufacturing businesses, as you suggest, then the exchange rate isn’t going to do it for you. Only nominal, yes nominal, wage falls will……

    • Explorer, tthe periphery never actually lost their industrial base fully and in fact have a much higher percentage of manufacturing GDP than the UK or Australia. That´s the reason why, for example, car manufacturing switched so quickly from north to south. As for salaries, a typical blue collar goes for about 18K incl social security in Spain and even lower in Portugal. The problem right now is not so much private industry being able to compete but reducing public spenditure to a more sustainable level, in particular due to the swollen number of retirees (particularly public ones) with oversized pensions.