The financial sector cripples Eurozone growth prospects

Ilmārs Rimšēvičs, Governor of the Bank of Latvia, Andrus Ansip, Estonian Prime Minister, Valdis Dombrovskis Latvian Prime Minister and Andris Vilks, Latvian Minister for Finance, all applauding, at midnight of 31 December 2013. The next minute Latvia joined the Eurozone. They all stand next to a poster with a 1-euro coin and the inscription “Euro. Latvia grows.” (in the foreground, from left to right). (EC Audiovisual Services).

According to a European Central Bank Press release published on 3 January 2014, Eurozone banks further reduced their overall outstanding balance of loans to the private sector during November 2013. Given that industrial multinationals and big services firms do not rely on bank loans for their financing, it’s mainly the SMEs that have been deprived of the means to support their investment projects. Let’s dig a bit deeper into that.

Aggregating loan balances for the entire euro area hides, however, a dreadful reality in certain member states and sectors. In fact, some peripheral Eurozone countries hit by crisis like Greece, Italy, Spain, Portugal, Ireland and others are faced with completely different bank loan options than their counterparts in core member states like Germany and France. It must be also noted that, according to ECB’s Bank Lending Survey published last October, loan queries by SMEs in peripheral countries are usually denied by banks, in contrast to usually positive responses the SMEs get by the lenders in core countries.

Pariah SMEs and countries

Put all that together and the result is that the new reduction of the overall loan balance (to the entire private sector) in the euro area last November was much more elevated in the case of SMEs in peripheral countries than the aggregate “-2.3%” found by the ECB. There is more to it though; the relevant Press release published by the central bank on 3 January 2014 also revealed that in the three month period under scrutiny, the negative evolution of the aggregate balance of loans accorded to the private sector kept deteriorating from -2.1% in September, to -2.2% in October and finally with -2.3% in November 2013.

Undoubtedly, those negative developments in the financial sector of the Eurozone economy will affect its macroeconomic prospects for many months to come. It also seems that, soon, the deep downturn of the real economy in the periphery won’t be outweighed by the sluggish growth in Germany and some other small core Eurozone countries. Even Holland is still in recession. As a result the entire Eurozone may return to the negative area of the graph.

How difficult is it for the SMEs?

Coming back to ECB’s Press release, Eurozone’s monetary leader reveals that the situation was even more difficult as far as the credit conditions are concerned in relation to the ‘residents’, a term meaning all economic players. It stresses that “Turning to the main counterparts of M3 on the asset side of the consolidated balance sheet of Monetary Financial Institutions (MFIs), the annual growth rate of total credit granted to euro area residents was more negative at -1.4% in November 2013, from -1.0% in the previous month… while the annual growth rate of credit extended to the private sector was more negative at -1.6% in November, from -1.4% in the previous month”.

Obviously, the above paragraph means that the situation is worse when the issue came to loans. This is because loans are a part of credit, the rest being other forms of financing like equity issues. However, the SMEs have no access to those other forms of financing and depend almost exclusively on banks to finance their investment projects. No need here to repeat the importance of the SMEs in the real economy on every account (GDP growth and employment).

This said, it’s very interesting to dig a bit deeper in the constellation of loans to the private sector. In relation to that, the ECB found that the situation was worse when it counted the loans accorded to the private business sector, after excluding the credit accorded to households and the private financial sector. Let’s see to that.

Even worse

The same Press release observes that, “The annual growth rate of loans to non-financial corporations stood at -3.9% in November, compared with -3.8% in the previous month”. In short, the real economy businesses received 3.9% less credits, in comparison to -2.3% for the entire private sector. No need to stress again that, for the reasons stated above, we can make an educated guess that the reduction of loans accorded to SMEs in peripheral countries must have been more than double the overall relevant figure for Eurozone’s business sector (-3.9%) that is around -8%.

All in all, there is no doubt that during the next few months Eurozone’s real economy will pay the price for the inability of its banking sector to consolidate. The same is true for the political inaction to reduce the fragmentation of the euro area financial markets. This is directly related to the political decision to postpone for at least four years the enactment of the real Banking Union. Undoubtedly, this historic error will delay the resumption of Europe’s economy for at least as many years.