Caution brings safety

ECB keeps zero rates to overcome fear of lending

A bird in the hand is worth two in the bush - or caution brings safety - has become a slogan of bank customers during the pandemic. Before Covid-19 hit, the global economy was on the rise - companies were not hesitant to take out loans, investing in new business ventures and creating jobs, individuals were taking out mortgages as well as consumer loans to finance renovation works, vacations or car purchases. In the aftermath of the coronavirus pandemic outbreak, however, the world stood still.

Rarely any sector maintained its growth rate, let alone registered an increase, with online commerce being one exception. Millions of people lost their jobs, a number of industries were pushed to the brink of collapse.

Well-paid workers with prestigious professions, such as those employed in the air transport industry, were forced to retrain after losing not only the opportunity to do their job, but their licence as well. The owners and employees of hotels, restaurants and travel agencies were abruptly forced to shut down. This circumstance changed everyone's priorities in a flash. The fear of contracting the virus not only limited social interactions, but created uncertainty around people's financial situations. Across the board, even those of us who did not lose our jobs, we all were growing legitimately worried about food security and being able to pay the bills. The series of lockdowns and the unknowns that each day brought affected every aspect of our lives.

Despite the financial support that governments provided to citizens and companies, the so-called credit vacation and the billions allocated to the worst-hit sectors, individuals and businesses remained cautious. The financial relief failed to put individuals and businesses at ease because countries kept going in and out of lockdowns. People were careful with their money and any purchase that was considered a luxury was deferred.

Many wondered how was it that the share of bad loans shrank during the recession even though numerous industries were brought to their knees and millions of jobs were wiped out. According to mid-April ECB data, the level of bad loans in the EU was reduced to a record low of 2.63%. The latest slump in bad credits was registered in the last quarter of 2020. This is the lowest level of bad credits since the start of supervision in 2015, despite a deep and scarring Covid-19 recession.

Some bank industry officials believe that aversion to taking risk in an uncertain economic and political environment is one possible explanation. Economic uncertainty made defaulting on loan payments a distinct possibility for borrowers so they opted to play it safe. As a consequence, consumers (both individuals and businesses) preferred to sit on their money instead of investing in new projects, even though interest rates on loans are extremely low while those on savings accounts are near zero. Some banks took their deposit products off the market, and if just a couple of years ago holding one's savings in the bank yielded a return, now savings accounts are associated with service fees and close to no return. Some banks went even further by introducing fees for opening a deposit account. But the low and in some cases even zero return on deposits turned out to be less of a factor compared to uncertainty, and so deposits kept growing, with some financial institutions reaching their annual deposit targets by the end of March.

Banks stayed stable and have managed to improve their loan books thanks to government guarantee and credit schemes that are keeping the corporate sector afloat. ECB warned the European policymakers that a too early withdrawal of stimulus packages will pose serious risk for economies. “At the moment, risks from the early withdrawal of policies are higher than the risks associated with keeping support measures in place,” ECB Vice President Luis de Guindos said.

Despite bank stability and consumers remaining cautious so far, some Eurozone financial institutions are expected to further tighten their credit standards over the second quarter of this year as the pandemic-induced recession in the bloc is persisting and threatening to disrupt the upcoming tourist season. That is what the results of the ECB's latest quarterly study on standards for extending bank loans in the Eurozone indicates. A large portion of Europe's service industry has been staying afloat thanks to emergency relief, and the ECB is worried about banks getting stingier with loans, causing companies to fold and, by extension, putting the European economy under pressure. Loan approval criteria for companies were tightened in some countries in the first quarter, with lenders foreseeing even more of a tightening in the near future coupled with a possible rise in loan demand. Credit approval standards were tightened for companies in Germany, Spain and Italy, while staying unchanged in France, according to the ECB. The institution's latest study also reports a decrease in loan demand owing to companies delaying investments whilst relying on liquidity buffers or direct government support for their survival.

In terms of home loans, credit standards were slightly loosened in the first quarter, but banks expect this trend to be reversed in the second quarter when net demand for mortgage loans starts to grow, ECB data shows. The number of mortgage loan consumers is declining because of poor job security casting a shadow of uncertainty over people's ability to cover their mortgage payments. In addition, homes have become an unappealing investment choice because of low return. Just last year, renting out a home yielded a decent annual return, but now these properties mostly burden their owners with expenditures. Some tenants have vacated their accommodations and returned to their family homes. This applies to both people who have lost their job and people who have the option to work from home.

The ECB promised ultralow borrowing costs in the coming years and stepped up its asset purchases last month in the hope that lower wholesale loan costs will trickle down to businesses and consumers. Demand for business loans may still bounce back in the second quarter, especially among small and medium-sized enterprises, as more stringent mitigation measures drive up the need for funding, the ECB notes.

On 22 April the ECB decided to leave unchanged its interest rates at zero levels and earmarked intentions to continue buying bonds to ease the pressure caused by the pandemic. “The interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unchanged at 0.00%, 0.25% and -0.50%, respectively”, the ECB said in a statement. The Governing Council will continue to conduct net asset purchases under the pandemic emergency purchase programme (PEPP) with a total envelope of €1,850 billion until at least the end of March 2022 and, in any case, until it judges that the coronavirus crisis phase is over. Net purchases under the asset purchase programme (APP) will continue at a monthly pace of €20 billion. The Governing Council continues to expect monthly net asset purchases under the APP to run for as long as necessary to reinforce the accommodative impact of its policy rates, and to end shortly before it starts raising the key ECB interest rates.

Whether the ECB's eased monetary and interest rate policy will give banks confidence and make them refrain from further tightening credit approval criteria remains to be seen, but one thing is for sure - until there is economic and political stability, individuals and businesses will remain cautious and true to the mantra “fear keeps you out of trouble”.

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