Yannis Stournaras: Measures to revive credit markets: best practices
and pitfalls
Speech by Mr Yannis Stournaras, Governor of the Bank of Greece, at the IMF/Bank of
Slovenia high-level seminar on "Reinvigorating Credit Growth in Central, Eastern and
Southern European Economies", Portoroz, 26 September 2014.
* * *
The global financial crisis has impaired the ability of the financial system in the euro area
to channel funds to the real economy, in particular for financing of long-term investment and
SMEs. Banks in the euro area have been particularly affected as the financial crisis was
followed by a sovereign-debt crisis, which has set in motion a negative feedback loop
between banks and sovereigns. As a result, over the past six years, bank credit to the real
economy and, in particular to SMEs, has fallen dramatically in the EU. Credit, which had
been growing at double-digit growth rates before the global financial crisis, has contracted
during the past few years.
The crisis also hit banks in the Central, Eastern and Southern European region as foreign
bank engagement in the region declined and the over-indebtedness of households and
businesses, a legacy of the earlier credit expansion, led to a large and rising volume of
nonperforming loans. In some cases, those have reached, or exceeded, 20 per cent of total
loans. As a result, bank credit in the region declined from average growth rates above 30% in
the period 2003-2008 to close to zero or even negative rates of growth in the recent years.
Bank credit is particularly important for economic growth in the EU. This situation is
attributable to the fact that European economies are heavily dependent on bank
financing. This dependence on banks is in contrast to the US, where capital markets play a
bigger role in financing the economy. Central, Eastern and Southern European economies
are also bank-based financial systems in which capital markets remain relatively
underdeveloped. Consequently, bank deleveraging, combined with increased risk aversion
on the part of investors, has affected the ability to finance sustainable growth throughout the
region.
A key characteristic of the economic recovery in the euro area at the present stage is the
weakness of bank lending to the private sector in general and to companies in particular.
This situation applies at both the aggregate level and for many individual countries.
The situation appears to be better in the Central, Eastern and Southern European region
(perhaps with the exception of Turkey), as credit growth remains on average positive, but is
nevertheless too weak to support satisfactory rates of sustainable growth. In particular, there
are countries, like Bulgaria, Bosnia and Herzegovina and FYROM, where credit to the private
sector is experiencing a moderate recovery but in other countries, such as Slovenia, Serbia
and - to a lesser extent Croatia and Romania - bank credit growth to the private sector and
in particular to enterprises is still negative.
As Fabrizio Coricelli discusses in his presentation, creditless recoveries are not uncommon
in the aftermath of financial crises, in particular when financial crises were preceded by
periods of credit booms to the private sector. Calvo et al (2006), in a seminal paper published
in the American Economic Review, describe creditless recoveries as "Phoenix Miracles". The
phenomenon of creditless recoveries has been documented mainly in Emerging Market and
low-income economies but seems to also play a role in industrial countries. Empirical
evidence suggests that creditless recoveries are more likely when the preceding recession
was deep and when the recession coincided with a banking crisis. Several other factors also
play a role: the openness of the economy to financial flows, the degree of export
dependence, the degree of external adjustment during the recession and the stance and mix
of fiscal and monetary policies.
Several explanations of this phenomenon have been proposed in the literature. One
explanation is that economies can rebound without bank credit because capacity utilization is
low during a recession allowing GDP to recover mainly through the absorption of unused
capacity rather than through investment. A second explanation is that, in the absence of
bank credit, firms increasingly use internal finance and trade credit. Furthermore, even if
bank credit is declining, bank credit may be reallocated toward more-dynamic sectors, thus
allowing an economic rebound.
Empirical research at the Bank of Greece suggests that the probability of a creditless
recovery depends on two additional features of the economy: First, the saving - investment
gap, in other words, the net financing needs of the private sector and, second, the degree of
a country's fiscal and external adjustment during the recession. In particular, the lower are
the net financing needs of the private sector at the bottom of the recession, the more likely it
is that the economy can recover without bank credit. Since the gap between investment and
saving can be financed through either capital inflows from abroad (in other words via
currentaccount deficits) or through lower budget deficits (in other words by freeing private saving to
finance investment), saving-investment imbalances naturally correspond to fiscal and
external imbalances.
A second important implication of this research is that the degree of a country's fiscal and
external adjustment during the recession plays a significant role during the recovery. In
particular, the probability that a country may experience a creditless recovery is higher in
countries that have followed economic adjustment policies during the recession to reduce
their external and fiscal deficits. This result has important implications for both countries of
the euro area periphery and countries of the Central, Eastern and Southern European region.
Nevertheless, creditless recoveries are suboptimal outcomes from an economic policy
perspective since, as has been observed by several researchers, creditless recoveries are
on average weaker than recoveries with credit. As Fabrizio Coricelli also points out,
creditless recoveries may have negative effects on long-run potential growth by affecting
investment and the stock of productive capital but also by increasing long-term
unemployment.
A number of actions may be undertaken in order to address the problem. I will confine my
remarks to three areas: monetary policy, confidence in the banking sector and
initiatives that target the mobilisation of funds from capital markets thus broadening the
sources of financing the economy. I will focus on our recent experience in the euro area, in
general, and Greece, in particular, where the banking system has undergone a significant
transformation over the past few years. Overall, my emphasis will be on measures which aim
to revive bank credit and to mobilize funds from capital markets.
On monetary policy, the ECB has taken important actions to improve confidence and to
restore the smooth operation of the monetary transmission mechanism. Credit growth would
have been significantly more negative had it not been for these actions.
The policy rate is now at an historical low of 5 basis points. Non-standard measures,
including the Targeted Long-Term Refinancing Operations (TLTROs), the ABS Purchase
Programme and the 3rd Covered Bond Purchase Programme will inject liquidity into both
banks and markets.
The establishment of the Banking Union is restoring confidence in the banking sector.
The supervisory authorities are assessing the resilience of banks and requesting injections of
capital, so that confidence in the quality of bank balance sheets will be restored. In this
respect, the Comprehensive Assessment and the EU-wide stress tests, which are
currently under way, will be key to improving confidence in the banking sector. Banking
Union will also help reduce financial fragmentation.
The faster banks clean up their balance sheets, the easier it will be for them to regain
confidence, to attract fresh capital from private investors and to provide credit to the
economy.
At this point allow me to say a few words about Greek banks. Following the first
recapitalization of our banks in 2012, we began to reform and consolidate the banking
system. Banks sharply reduced reliance on central bank funding, while forming provisions for
bad loans. As a result, they have been able to attract private investors.
Early this year, we concluded follow-up stress tests that were exceptionally well received by
the markets. Following the release of the results of the stress tests in March, core banks
completed much larger than requested capital increases to the tune of €8.3 billion with issues
being significantly oversubscribed. Two systemic banks have repaid state aid that has been
in the form of preference shares. All four systemic banks are now under private
management.
These are the signs needed to restore confidence and lay the foundation for the healthy
financing of the economy at a later stage.
Returning to the broader picture, it appears that bank credit will remain constrained at least
until the European stress-test is completed and banks adjust to the results of the exercise.
The burden of NPLs in economies which have gone through a deep recession - and Greece
is a good example here - will be a major factor constraining the supply of bank credit in the
medium term. Given the limited quantity of resources, it is important that banks use these
limited resources in a way that improves allocative efficiency. In other words, they have to be
channeled to the most productive uses.
Nevertheless, despite the important role that banks will continue to play, in the EU,
particularly for SMEs, it has been clearly communicated by market participants that there is a
pressing need to broaden the sources of long-term financing in Europe.
Broadening the sources of financing of the economy toward capital markets should be
viewed as one of the key priorities of economic policy.
In this respect, the development of a deep, transparent and robust European securitization
market for corporate loans would improve risk sharing and increase banks' lending capacity
to corporates and, in particular, SMEs.
And this solution will probably serve its purpose better this time than previously, since the
lessons of the inadequate regulation of some securitisation models in the past can be taken
into account.
The ABS and the Covered Bond Purchase Programmes will provide an initial boost,
especially for the European ABS market which has lain largely dormant since 2008.
However, in my view, if we are to move farther towards the development of a market for
corporate loans, a concerted effort is needed in several directions. A list of key priorities in
order to revive credit markets should include the following:
First, further measures to revive the market for securitizations, in particular for SME
bank loans. Securitization is an important instrument to promote bank credit. Allowing banks
to securitize and redistribute SME loans to a broader investor base can provide banks with
capital relief and allow them to lend to the real economy. This is not an easy task given the
stigma attached to securitization following the global financial crisis, when the "originate to
distribute" model led to excessive leverage and financial fragility. Of course, lessons have
been learned since then, and the regulatory framework has been adapted in a way that
makes a repeat of past mistakes unlikely. For this securitization to work in a way that does
not endanger the resilience of the financial system, we must ensure that only high quality
assets that are simple and transparent are used in securitizations. In this respect, it is
important to develop a set of rules that allow the definition of a pool of "high quality
securitizations" at the EU level.
Second, changes to the prudential treatment of securitizations. It is essential, in my
view, to adjust the regulatory framework for securitisations in a way that provides banks with
incentives to engage in the market. Capital relief for banks' holdings of Asset Backed
Securities which are simple, transparent and robust could provide an answer. The second
aspect of regulation relates to potential investors, such as insurers, pension funds etc. The
regulatory framework should allow for a fair treatment of high quality ABS relative to ABS
products with higher risk profiles, in order to provide long-term institutional investors
incentives to trade in the market.
Third, policies to promote better access of SMEs to capital markets. As is well known,
corporate bond markets work well for large corporations while they are not attractive to
SMEs, which remain largely dependent on bank loans for financing. Efforts should be
undertaken to reverse this trend and promote the access of SMEs to capital markets. The
development of "minibond" markets for SMEs in Italy and Germany could serve as examples
to gain insights into best practices for the establishment of SME markets. The development
of bond and equity markets for SMEs and mid-sized companies would also encourage more
cross-border investment within the EU and from foreign investors.
Fourth, measures to develop alternative financial intermediaries for young companies
and SMEs. In this context, efforts should be intensified toward the creation of a risk capital
market for non-listed companies such as a market for venture capital funds and markets for
infrastructure financing. MiFID II is an important step towards improving the functioning of EU
trading venues and setting the stage for the development of SME capital markets. However,
further steps are necessary, in particular to correct differences throughout the EU in the tax
treatment of these products both at the issuer and investor level.
Fifth, measures to improve investors' access to business, credit and financial
information on SMEs. It is well-known that most SMEs are not rated by rating agencies.
The lack of adequate and readily available information on the credit quality of SMEs is a
structural problem in the EU as a whole and in the Central, Eastern and Southern European
region, in particular. This is one of the major reasons that SMEs in the EU have historically
faced significant difficulties to access funding from capital markets.
There is, thus, the need of a harmonised EU approach to credit scoring comparability of SME
data. Improving the availability of financial information is paramount in allowing investors to
gauge the riskiness of securitized products. In this respect, it is important to develop national
credit registers for SMEs, allowing for higher transparency, standardization and comparability
of underlying assets.
A final word of caution is in order. Most of the measures I discussed above will likely have
only medium- to long-term effects in reviving credit markets in the EU because most of these
measures constitute fundamental changes in the structure of the financial system. Such
structures naturally change only gradually over time. In the short term, monetary policy will
continue to play the major role in determining liquidity provision to banks and the cost of
funding for the private sector. Non-standard monetary policy measures and progress towards
a banking union are, thus, of prime importance, in order to reduce market fragmentation and
allow the normal transmission of monetary policy to the most vulnerable areas of the
monetary union.