ECB Paints Lipstick on Euro's Banking Pigs
Try this thought experiment. You're in the business of lending euros to European companies. But you owe your own creditors $2.3 trillion -- yes, $2.3 trillion -- in loans that all come due by the end of next year. Rolling those loans over is becoming tricky. Out of the blue, your regulator offers you free money and says you won't have to repay it for four years.
Would you (a) fill your pockets with the money and make as many new loans as your processing department can cope with? Or (b) fill your pockets with the money, repay your debts and, after reflecting upon the unhealthy proportion of customer debts already filed under the category "non-performing" because they're not being repaid, retire to your office, close the door and try as hard as possible not to make any new loans.
That, unfortunately, summarizes the situation in Europe's banks. And that's why the European Central Bank's announcement last week that it is expanding its Targeted Longer-Term Refinancing Operations, known as TLTROs, will paper over the cracks in the finance industry's balance sheets without funneling extra money into the real economy.
The business climate in the euro region provides ammunition to those who suspect negative interest rates hurt business and consumer confidence, in turn depressing consumer prices. When the central bank is telling you the future is so bleak that it needs to pump yet more cash into the economy, why would you invest in a new factory? The European Commission's monthly survey of manufacturing confidence shows companies haven't been optimistic about the outlook since the middle of 2011:
As a result, companies aren't exactly beating on the doors of the banks for money. Just 29 percent of bank lending officers surveyed by the ECB anticipate increased demand for loans; while that's an improvement on most of 2011 and 2012, when respondents were anticipating a drop in their lending businesses, it still suggests that what ails the euro economy is on the demand side of the equation, not the supply side:
There's another issue lurking in the background. Europe recognizes that its companies are still far too reliant on bank loans rather than capital markets, in contrast with U.S. companies. Jonathan Hill, the European commissioner for financial services, is spearheading efforts to address that issue by forging a capital markets union. As he said in September, Europe's economy is about equal to that of the U.S., but its equity markets are less than half the size, and its debt market is less than one-third.
And yet, here we are, with the central bank trying to engineer a wealth transfer to the banking sector which, if it succeeds, can only increase the region's dependence on bank funding.
Whatever the merits of allowing central banks to be in charge of supervising both monetary policy and the financial system, it's clear that these should remain two separate functions so that the needs of the financial system don't dictate the design of monetary policy. Yet the latest ECB moves blur that boundary, with Draghi explicitly referring to how the TLTROs are designed to address the refinancing challenge faced by banks:
It's a four-year operation at an attractive price in an environment of increasing volatility. And also an environment of large upcoming bond redemptions, bank bond redemptions. Banks face sizable forthcoming funding needs and so this occurs in an environment where the price of bank debt is volatile and uncertain.
While it's clear that a bank worried about how to refinance billions of euros of maturing bonds in the next few years is less likely to be expanding its loan book, it's less obvious why that funding climate should be a primary concern for Draghi. Commercial banks, not the central bank, should be responsible for making their bonds attractive. The price of bank debt is "volatile and uncertain" because Europe's banks still don't have a business model that investors find viable, never mind beguiling. It seems like a worrying form of mission creep when the needs of the banking industry are shaping monetary policy quite so prescriptively.
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