ECB: A revolutionary idea to revitalize the European economy with cheap loans to SMEs

Mario Draghi, President of the European Central Bank, delivering a speech at the European Parliament. (EP Audiovisual Services).

IMF and World Bank’s spring meetings in Washington DC last weekend gave the opportunity to the European Central Bank (ECB), supported by the Bank of England (BoE), to launch a new monetary policy ‘offensive’ in order to revive the stagnant European economy. Mario Draghi, President of ECB clearly stated that the Eurozone’s central bank will provide “further stimulus” for the economy, if inflation remains at its present dangerously low levels of 0.5%, away from the target which has been set below but close to 2%. He also stressed that for the first time the ECB may target the parity of the euro vis-à-vis the other major currencies. During the past months the external value of the single currency has risen to very high levels, debilitating both the inflation rate and the economic activities in the euro area. There is more groundbreaking news though.

The ECB and the Bank of England in a rare occasion, presented a joint paper entitled, “The revitalisation of the European securitisation market”, aimed at helping the European SMEs. The two major European central banks stress that this financial instrument (securitization) can complement other long-term wholesale funding sources for the real economy, including for small and medium-sized enterprises (SMEs). This is the first time that the two central European banks show such a vivid interest in SMEs financing. Seemingly, the financial conditions in Europe must have developed so adversely during the past few months, as to make possible a catastrophic return to recession.

ECB and BoE join forces

The idea is that in a transparent and prudent way, overseen by the European monetary and banking authorities, the EU lenders can put together their prime quality loans and securitise them. Then according to the ECB’s plan “connecting SME financing needs with the funds of bank and non-bank investors via securitisation of SME loans can assist banks’ ability to fund and distribute risk. Both channels have the advantage of not interfering with the allocation mechanism of a market economy”.

In this way prime quality Asset Backed Securities (ABSs) could be bought by long-term investors, like insurance companies and pension funds, and thus refinance the lenders and the lenders in their turn accord more loans to SMEs. The key to this new cycle of funding, aimed at financing the real economy and more particularly the SMEs, is the bank Asset Quality Review to be effectuated by the ECB. Only after the ECB and the other EU banking authorities have ‘sealed’ those securities, the loan-securitisation-loan cycle can progress based on solid and prudent steps.

New financial instruments for SMEs

The European Sting noticed last week that something important was jointly prepared by the ECB and the Bank of England, aimed at helping the SMEs. Last Tuesday the Sting noted that Yves Mersch, Member of the Executive Board of the ECB, spoke at the Deutsche Boerse – Clearstream ‘Exchange of Ideas’ event, in London. On this occasion he proposed ways and means to revitalize the anemic ABSs market and he concluded “It is not too late to change course: not all EU securitisations deserve the stigma attached to them for the past few years. There is a need to restore coherence across financial sectors in particular amid the unfavourable regulatory treatment of (high quality) securitisation instruments, without violating prudential principles. By doing so we must act fast and in a manner that is sensitive to our own European reality. If the Bank of England and the ECB were to put forward a joint statement on this issue at the forthcoming IMF Spring Meetings, it would underline the European determination to decisively move forward”.

This was exactly the announcement three days later the ECB and the Bank of England jointly produced during the IMF – World Bank’s Spring Meetings in Washington. Obviously Mersch knew about the new policy option and took the precautions to inform the capital markets that Europe will go for it. It’s a revelation to see the ECB and the Bank of England to jointly undertake painstaking efforts in order to help the real European economy and more so the SMEs.

The expensive euro leads to deflation

However Draghi had more to say last weekend in Washington. Given that the ECB’s basic interest rates are already zeroed or close to zero, the extraordinary monetary measures can only rely on the money printing machine. Reportedly the central bank is currently studying the tools to be used in this direction. The forms the monetary easing can take are not many though. The most important of them are the relaxation of the terms under which the lenders are refinanced by the ECB on collaterals, and the straight forward acquisition of bonds in the secondary market.

Now the ECB and the BoE propose a new way of refinancing the real economy through the restoration of the ABSs market under the guidance of the monetary and banking authorities. Nevertheless in all those cases the common denominator is that the ECB will either print money or issue guarantees for ABSs, which is tantamount with possible future money printing.

Draghi’s commitment

The problem is though that the Treaty of Maastricht restricts ECB’s mandate exclusively in taking care of the inflation rate; nothing else. This said, a lot of people, particularly in Germany, are ready to challenge at the European court rooms the new policies applied by Draghi. In view of that the President of ECB noted from Washington that, “The rise of the single currency’s exchange rate is one of the main reasons eurozone inflation is at a dangerously low 0.5%”. Then he added “a stronger euro would act as a trigger to looser monetary policy”. By this Draghi is directly connecting his new extraordinary monetary measures with the dangerously falling inflation rate, an issue right within ECB’s mandate.

It’s quite clear then, that the latest and quite out of the ordinary joint announcement by ECB and the Bank of England is a strong indication of the direction those extraordinary measures are bound to take. In any case the target will be to facilitate the financing of the SMEs, through more loans from the banking system. Not to forget that the small business cannot address themselves directly to the capital markets for financing.

All in all the ECB, backed by the Bank of England, is certainly opening the way to a new financial environment in the euro area, designed to revive the real economy through ample and cheap bank loans to the SMEs. The banking system of Eurozone as it stands now is quite incapable of financing the real economy. That’s why the ECB is planning these new policy lines, in order to save Eurozone from a new stagnation or even recession period.