Euro area: Credit Tightening in Q1 May Slow ECB's Exit Pace

• The euro area bank lending survey shows that banks tightened credit standards to both non-financial corporations and households in the first quarter, but not by much. The outlook for Q2 indicates further tightening for both enterprises and households.
• The most important drivers for tightening are the banks' credit supply-side considerations related to access to market financing and their liquidity positions. Also the banks' perceptions about risks and the overall economic situation contributed to a tightening of credit standards for loans to enterprises.
• Demand for loans from enterprises increased substantially in Q1. Nevertheless, the increase was smaller than expected. Interestingly, an increase in financing demand for fixed investment contributed positively for the first time in more than two years. The survey suggests that demand will continue to increase in Q2, especially for the SMEs.
• The euro area banks expect that access to money markets will ease and possibly improve overall in the second quarter of the year. However, access to debt securities markets could continue to be problematic, but likely less than in Q1.
• Today's release may affect the ECB's exit pace. If anything, this supports further postponement of the return to fixed allotment and yield support for a three-month hiking interval in the current hiking cycle.

Details

The bank lending survey shows that net 6% of banks tightened credit to enterprises in Q1 compared with no changes in Q4 10. The outlook for Q2 suggests minor further tightening. The net percentage of banks expecting credit tightening for loans to enterprises in Q2 is 3%.

The most important factors contributing to the tightening were banks' credit supply-side considerations. Banks reported that access to market financing was among the factors explaining the tightening, but expectations regarding overall economic activity also contributed. Interestingly competition continued to contribute to an easing of credit standards for loans to enterprises.

The net percentage of banks saying that demand for loans from enterprises increased rose substantially from 10% in Q4 to 19% in Q1. Nevertheless it was less than expected in the previous survey round. The main driver for the increased demand was increased financing needs for inventories and working capital. Interestingly, an increase in financing demand for fixed investment contributed positively for the first more than two years. The survey results suggest that the demand will continue to increase in Q2, especially for SMEs.

Credit tightening for loans to households for house purchases has increased from net 9% in Q4 to net13% in Q1 and for consumer credit and other lending it has increased from 2% to 7%. The expectation is that credit tightening for households will continue in Q2, but slightly less than in the first quarter.

As was the case for loans to enterprises banks, the tightening for loans to households was due to the increased cost of market funding and balance sheet constraints. Also, the general perception of risks appeared to have contributed substantially to the credit tightening in Q1. As a result banks reported an increase of margins on both riskier loans and average loans.

Banks reported a significant drop in demand for loans from households for house purchases to net -10% in Q1 from net +24% in Q4. This was due to concerns on housing markets prospects. The outlook from the survey suggests a minor increase in demand for mortgages in Q2. The net tightening for consumer credits also increased to net 7% in Q1 from net 2% in Q4. This was driven by deterioration in creditworthiness of borrowers, credit supply considerations and risk perception.

When asked about the future, the euro area banks said they expected that access to money markets would ease and possibly improve overall in the second quarter of the year. However, access to debt securities markets could continue to be problematic, but likely less than in Q1.

Assessment and expectations

All in all, the ECB's bank lending survey shows that banks access to financing is not improving as fast as one could hope for. This has resulted in a mild credit tightening that is expected to continue in Q2. However, loan demand from enterprises is pushing margins up.

Today's release may affect the ECB's exit pace. If anything this supports a further postponement of the return to fixed allotment and yield support for a three-month hiking interval in the current hiking cycle. Although it will be interesting to see if next week's press conference signals that the ECB's assessment of the financial market conditions are in line with the survey results we will likely have to wait for the June meeting to get any major new insights with regard to the ECB's plans for the exit strategy in 2011.