The challenges of lending for 2013-2015 and beyond

The above figures show that between 2007 and 2012, the banks continued to grant plenty of credit and at low rates (See 1 euro of credit for each extra euro saved between 2007 and end 2012). That is therefore beyond doubt. To date there has been sufficient credit available for satisfactory files – as the figures show. However, in recent years there has been a perception that the financial sector has not been properly fulfilling its role as financier of the economy, both for households and for businesses. Public opinion often feeds this perception.

The figures indicate that this perception is not entirely accurate (see Savings are not asleep). But that does not prevent the current economic reality from creating a more difficult credit climate, both for long-term loans and for certain business loans.

Since mid-2012, the growth in lending has been slowing down, for example. For both mortgages and loans to businesses, both demand and the number of loans granted have fallen in recent months. There are three main reasons for this:

  1. difficult demand for credit
  2. declining quality of credit applications
  3. regulations which make providing credit more difficultt

Difficult demand for credit

In 2012, the number of credit applications from businesses was down 11% on 2011. The number of applications for mortgages also fell by 27.5% last year compared with 2011. This kink in the curve of the number of applications logically also produced a dip in credit production. Last year, the production of credit to businesses was down 10.3% on 2011 while the number of mortgages fell by 34% over the same period. Two factors are behind the drop in the number of applications: the difficult economic context and the scrapping of a number of energy-saving measures and of “green credits”.

Low growth forecasts weigh on the confidence and spending decisions of households and entrepreneurs, and therefore on the demand for credit. That was also confirmed in the study by Professor Huyghebaert, which clearly showed that lending is procyclical in character: a growth in the gross domestic product (GDP) and available income inevitably leads to a growth in demand for mortgages, consumer credits and investment credits. In the difficult economic climate of the last few years, however, the demand for credit has shrunk. But even if credit demand would rise again, the challenges at hand remain.

In addition, a number of (mainly large) companies also chose to source financing from non-banking institutions. In 2012, for example, the market in corporate bonds boomed. The National Bank reported that the cumulative net issuance of corporate bonds (the total number of issues less those bonds that matured) in the year to 30 September 2012 amounted to EUR 7.6 billion. Over the same period, net financing via the bond market was significantly higher than net financing via loans from banks based in Belgium.

The low interest rates of the European Central Bank, which influences returns on savings acounts, helped facilitate the success of the bond market. That factor certainly tempered the demand for bank credit among large companies. Companies that can finance themselves on the bond market do not need to take refuge in bank credit, which causes a general decline in the demand for credit from businesses.

The bond market can be part of the financing mix, but consumers need to be aware that it also involves a risk. Also, smaller companies find it more difficult to access the bond market, and are still trying to finance themselves via the banking balance sheet. Following on from this, the financial sectors finds that it is precisely these companies that are also taking out bank loans more frequently than before to increase their financial breathing room. It goes without saying that bank credit is not always the best way of achieving this: additional bank credit also increases debt, making companies more financially dependent and therefore less solid.

Not only has demand for corporate credit fallen, but also demand for mortgages. The scrapping of measures such a green credit with interest indemnification means people are less willing to apply for and accept mortgages. Demand for mortgage credit rose again in April 2013, possibly temporarily.

Declining quality of credit applications

The deterioration in the economic situation not only affects the number of credit applications, but also their quality, certainly where businesses are concerned. Indeed, there are several indicators which suggest that credit applicants have not become stronger in recent years.

In a study of the financial independence of 256,000 Belgian businesses carried out on the basis of the 2011 balance sheets, the National Bank of Belgium found that the financial independence (the relationship between own equity and the sum of the liabilities/obligations) of companies has generally improved, but also that the financial independence of the smallest companies in particular remains problematic, and is even becoming more so. 

Since 2009, the degree of financial independence of SMEs appears to have fallen sharply. For the very smallest businesses, financial independence fell by as much as 12.7 percentage points over the last ten years. 17.3% of businesses in this smallest percentile even suffered negative own equity.

Being financially independent is extremely important for a business. Companies that are less dependent on outside resources also have fewer financial burdens that weight on their financial result. This also allows them to take out new loans more easily and at better rates if necessary. Conversely, less financial independence and therefore lower viability lead to a higher risk profile.

Unfortunately, more and more businesses seem to fall into the latter case, according to an internal Febelfin survey. Due to the continuing economic slump, Febelfin members seem to be receiving more and more credit applications from businesses with a high risk profile. The number of SMEs with a low risk profile that made an application for credit fell by 15.2% in 2012 compared with 2011. Conversely, the number of SMEs with a high risk profile that applied for bank credit rose by 18.6%. Here too, the smallest businesses appear to be the most vulnerable: among them, the number of high risk profiles has risen by 21%. For the sake of clarity it must be noted that the criteria by which banks assess companies’ sensitivity to risk have not changed compared with previously. In any event, the criteria must be approved by the National Bank of Belgium, which regulates financial institutions.

Obviously, the declining quality of credit applications also weighs on lending. Bankers have to manage risks, and must therefore take account of businesses’ viability and degree of financial independence. If these deteriorate, this inevitably leads to more credit rejections.

The financial sector is therefore calling on the government to launch measures to ensure that businesses, and certainly SMEs, can increase their own equity and thus become more financially independent and more credit­worthy.

Changing regulations

The capital requirements of the Basel III Accords could mean that over time financial institutions find it more difficult to meet the demand for credit. They could also lead to a sharp rise in the cost of credit in the long term.

The Basel III capital requirements were drawn up by the Basel Committee, a cooperative platform of banking regulators from across the world that meets at the Bank for International Settlements (BIS) in Basel, Switzerland. They require financial institutions to hold more capital and liquidity against their outstanding investments and loans.

In concrete terms this means, among other things, that financial institutions’ own equity must double to be able to continue providing the same volume of credit, but that banks also have to attract more stable financing and hold more liquid assets. The Basel III rules will be gradually implemented from this year onwards and must be fully in force in 2018. For Europe, the Basel III rules were translated into the CRD IV Directive.

In Europe, Belgian financial institutions have taken the lead in complying as quickly as possible with the Basel III rules: For this reason, between the end of September 2007 and the end of September 2012 the banks:

  • reduced their liabilities (the sum of the own equity and, among other things, the savings deposits and debts on the interbank market – the so-called debt capital) by 27.1%
  • increased their hard equity by 16.6%
  • reduced the ratio between own equity and the balance sheet total by 38.7%

Financial institutions are therefore undeniably more solid than before the financial crisis. And yet the transformation has hardly caused any damage to lending, as you have already read. Nonetheless, the further implementation of the Basel rules will inevitably have an impact on lending.

In particular, the NSFR component of the Basel III regulation will create particular challenges for Belgian banks. It provides that financial institutions must attract stable financing in the long term if they want to provide long-term loans. In concrete terms this means that a financial institution will find it more difficult to provide long-term credit to households or businesses if there is no offsetting long-term financing, for example in the form of a time deposit account.