Further reductions of business and consumer lending possible, affecting prospects for sustained economic recovery in the Eurozone
The forecast for business lending growth in the Eurozone in 2014 has been revised down for the second time this year. It has fallen from 1.6% to just 0.5%, as the near-term effects of banks preparing for the Asset Quality Review (AQR) hit home, according to the EY Eurozone Financial Services Forecast (EEFSF
). The baseline forecast is for lending growth to accelerate in 2015, this assumes a small capital shortfall as a result of the AQR.
However, modelling of more adverse scenarios shows that forecast for economic growth is vulnerable to any impact the AQR might have on bank lending. The EEFSF model shows that a constraint on lending of 0.4% or more would weaken the forecast for Eurozone GDP growth in 2015. Further EY analysis suggests that any capital shortfall larger than €60b would result in a constraint on lending of at least 0.4%.
Andy Baldwin, EY’s Global head of Financial Services, says: “Given how dependent consumer spending and SME financing are on bank lending in the Eurozone, the AQR could have a material economic impact. The hope is that it clears the decks for banks to support more sustained growth, but, if there is a large capital shortfall, the AQR could deliver a material knock – not enough to drive the region back into recession, but enough to prolong low growth or stagnation. The possibility of a further slowdown in bank lending to the real economy only makes it more important for European governments to stimulate long-term funding from other sources.”
Uncertain AQR outcome hangs over growth forecast for Eurozone economy
Estimates of the Eurozone banks' capital deficit post-AQR now range from €50b to €300b. The EEFSF baseline forecast assumes that the capital shortfall is towards the lower end of this range, in which case there would be no significant effect on bank lending. In this baseline scenario, business lending is forecast to grow by 3.8% and consumer credit is expected to grow by 2.9% in 2015, supporting real GDP growth of 1.4%. This outlook is supported by the fact that non-performing loans are forecast to fall from their peak of 8% of outstanding loans in 2013 to 7.6% by the end of 2014 and 6% by the end of 2015.
However, if the capital shortfall is any more than €60b, there will be a significant enough knock-on effect on business and consumer lending to damage economic growth. At a shortfall of this size, analysis by EY indicates that the forecast for business and consumer lending growth would be constrained by 0.4%; modelling of the impact on the economy using the EY Eurozone Economic Model shows that this would result in a 0.1% reduction of GDP growth.
If however, the shortfall was to hit the middle of the current range of market estimates, it is estimated that forecasts for business and consumer lending would be revised down by 1%. The knock on effect on Eurozone GDP would be a reduction of 0.3%, pinning growth back to an anaemic 1.1% in 2015.
And in the most extreme scenario, if the capital shortfall were to hit to the very top end of the current range of estimates, it is estimated that forecasts for business and consumer lending would be revised down by 2%. The knock on effect on Eurozone GDP would be a reduction of 0.7%, halving GDP growth to 0.7% in 2015.
Robert Cubbage, Banking and Capital Markets leader for EY in Europe, Middle East, India and Africa (EMEIA), comments: “No one can accurately predict the impact of the AQR or how banks will react to a capital shortfall. But the near-term effects of this spring-cleaning on lending are already having an impact. True, lending growth is expected to strengthen next year, but overall, it is increasingly uncertain that Eurozone banks will be able to achieve pre-crisis levels of credit growth in the foreseeable future. In fact, many remain under pressure to exit non-core businesses and reduce their overall leverage. So it is likely that some banks will adapt their business models by providing less direct lending to corporate customers in favor of advising them on accessing finance from a range of different sources.”
Should the shift into equities ring alarm bells?
The recovery continues to attract capital into European equities. As in the US, this trend is being mirrored by a widespread withdrawal from bond markets. The Eurozone’s ratio of equity funds to bond funds, which stood at 100% at the start of 2013, is predicted to reach 129% by the end of this year and 140% in 2015.
About the EY Eurozone Forecast
The forecasts and analyses presented in the EY Eurozone Forecast are based on the European Central Bank’s model of the Eurozone economy. This model embeds state-of-the-art economic theory and techniques and is used by the ECB to produce its quarterly forecasts of the euro area.
Assumptions made in the calculation of the economic impact of a capital shortfall resulting from the AQR
It is very hard to accurately predict the impact of the AQR or how banks will react to a capital shortfall. However, in order to model the effect a capital shortfall would have on bank lending, EY has made some assumptions about the amount of capital banks would raise through constraining their balance sheets and a judgment on how much of the lending could be picked up by the rest of the market (those banks not involved in the AQR exercise). We have fed these assumptions into the EY Eurozone economic model and we believe the results give a reasonable indication of the range of potential outcomes.
About EY Romania
EY is one of the world's leading professional services firms with approximately 175,000 employees in 728 offices across 150 countries, and revenues of approximately $25.8 billion in 2013. Our network is the most integrated at global level and its vast resources allow us to help our clients benefit from every opportunity. In Romania, EY has been a leader on the professional services market since its set up in 1992. Our over 450 employees in Romania and Moldova provide seamless assurance, tax, transactions, and advisory services to clients ranging from multinationals to local companies. Our offices are based in Bucharest, Cluj-Napoca, Timisoara, Iasi and Chisinau. From 1 July 2013, Ernst & Young becomes EY, the logo has been modified in response to this change and the company's new tagline becomes "Building a better working world". The new visual identity reflects the new strategy of EY, Vision 2020. For more information, please visit www.ey.com.