On 24 September 2020, euro area banks raised an additional €175bn in the fifth round of the so-called Targeted Longer-Term Refinancing Operations (TLTROs). The stock of outstanding loans, most of which now have a maturity of three years, has jumped by €1,130bn since January to €1,700bn.
The ceiling is currently set by the ECB at 50 per cent of the sum of the commercial banks’ outstanding loans to companies and households (excluding real estate loans) as of February 2019. This implies a credit limit for longer-term loans of around €3,000bn.
Because the ECB allots the full amount of requested credit, the outstanding amount of credit is driven by the demand of the individual banks. Most of the longer-term loans are distributed among four countries (as of the end of July): Italian and French banks accounted for 22 per cent each, German banks for 18 per cent, and Spanish banks for 16 per cent. This implies that in particular Italian and Spanish banks received over-proportional amounts of credit relative to their capital key (Italy 16.99 per cent, France 20.42 per cent, Germany 26.36 per cent, Spain 11.92 per cent).
To ensure that banks with higher risks have access to longer-term refinancing operations, the collateral requirements were relaxed in April. As even Greek sovereign bonds (rated BB-) were re-approved as collateral, loans to Greek banks increased from €7bn to €36bn. In addition, on 17 September 2020, the calculation of the regulatory leverage ratio was eased by the ECB.
The interest rate on longer-term refinancing operations is based on the interest rate of the ECB deposit facility, which is currently minus 0.5 per cent. If the commercial banks do not reduce the amount of outstanding loans in the period from March 2020 to March 2021, the interest rate can be lowered to minus one per cent during this period. Thus, banks receive subsidies if they take out additional loans from the ECB and pass them on to companies and households.
This “Funding for Lending” supports enterprises in the euro area, because additional cheap loans are available. Banks also benefit because bankruptcies are avoided and therefore the volume of potential nonperforming loans is reduced. The interest margins of banks — which were for a long time depressed by the ECB — can rise again thanks to negative interest rates on the funding side. On private capital markets, the refinancing costs would probably be positive.
Yet as the conditions for the continuation of loans are softened, investment projects with low returns are kept alive. For Japan, this phenomenon has been dubbed “forbearance lending”: many companies only survive because the banks do not sufficiently price in the default risk in a persistent low-interest rate environment. As necessary restructurings are postponed, the productivity gains and the expected return of these “zombified” companies are declining.
Recently, a BIS study has shown that the proportion of listed zombie companies in most euro area countries has been rising in trend even before the crisis. This process is likely to be intensified with the extensive coronavirus emergency lending. As of the end of July, Italian and Spanish banks already financed nine per cent of their total assets with central bank funds, which is more than twice that of German banks (four per cent).
All in all, the process of capital allocation, as it is usually the case in a market economy, is turned upside down. In the old world, companies applied for credit to finance investment. Banks provided credit dependent on the evaluation of the expected profitability of the investment projects.
Now, the ECB is the originator of lending and provides subsidies if banks prolong and provide new credit to enterprises. To prevent bankruptcies, the expected profitability of investment does not seem to be a main determinant of borrowing. Productivity gains are likely to continue to decline, eventually becoming negative.
Janos Kornai once spoke for the Central and Eastern European planned economies of soft budget constraints: since restructurings of loss-making state-owned enterprises was taboo to avoid unemployment, the state-controlled banking sector granted mainly unconditional loans, with the losses being covered by the state-owned banking system.
With the rising central bank funding, the euro area is moving into an increasingly soft budget constraint for a growing number of enterprises. The zombification that has already begun in the south of the monetary union is likely to spread to more and more companies all over the monetary union.
All this heralds gloomy growth perspectives for the euro area.