Collateral and Credit Rationing. The role of collateral in explaining and remediating the limited flow of credit to households and SMEs. ECRI Policy Brief No. 7, February 2014

European-wide data concerning both companies and households indicate that the credit rationing phenomenon, which has been predicted by theory, does in fact occur to a significant degree in the European credit market. Among SMEs, micro companies are most vulnerable and the current economic crisis has only made these concerns more pressing. Top-down use of the monetary transmission mechanism alone is insufficient to counter the problem. The other solution consists of a bottom-up, microeconomic stimulation of lending transactions, by focusing on collateral and guarantees. The data confirm the high importance that lenders – especially individual households and micro companies – attach to collateral and guarantees when making their lending decisions. As a consequence, we would argue that those parts of the law governing security interests and guarantees should be one of the primary targets for government policy aimed at improving credit flows, especially in avoiding a conflict between consumer protection measures and laws on surety and guarantees. This policy brief firstly aims to give an overview of the problem of credit rationing and to show that low-income households and SMEs are most concerned by the phenomenon. Focusing solely on loans as a way of financing and on the issues related to access to finance by micro and small companies as well households, it then sketches possible solutions focused on guarantees. This paper brings together data from the Eurosystem Household Finance and Consumption survey (HFCS), Eurostat, and both the latest wave of the extended biennial EC/ECB Survey on the access to finance of SMEs (EC/ECB SAFE 2013) and the latest wave of the smaller semi-annual ECB SAFE Survey, covering the period between October 2012 and March 2013.

Supporting Access to Finance by SMEs: Mapping the initiatives in five EU countries. ECMI Research Report No. 9, April 2014

This paper maps the initiatives to support access to finance for small- and medium-sized enterprises (SMEs) that were available at national level in 2012 in the five biggest European economies (Germany, France, the UK, Italy and Spain). This mapping distinguishes initiatives promoted and financed primarily through public resources from those developed independently by the market. A second breakdown is proposed for those sources of finance with different targets, i.e. whether the target is debt financing (typically bank loans at favourable conditions, public guarantees on loans, etc.) or equity financing (typically venture capital funds, tax incentives on equity investments, etc.). A broad set of initiatives has been implemented to close the funding gap of SMEs in these five countries. The total amount of public spending for SMEs, however, has remained well below 1% of GDP. Public subsidisation of bank loans has been by far the most diffused type of intervention. Despite the fact that this strategy might prove to be effective in the short term, it fails to address long-term sustainability issues via a more diversified set of financing tools.

The Impact of Banking Structural Reform on Household Retail Finance. ECRI Commentary No. 13, 7 October 2014

There are two main objectives behind the EC proposal on banking structural reform: the financial stability objective and the economic efficiency objective. If it is implemented, the reform should reinforce the stability and economic efficiency of household retail activities through lower contagion, better resolvability in the event of failure, more harmonised supervisory practices across the EU and more resilient household demand for retail loans. However, it could also trigger counterproductive effects that could partly undermine the expected benefits. These potential negative effects are not appropriately assessed in the impact study of the proposal published in January 2014 and will require further consideration in the coming months. In particular, the stability of household retail finance could be strengthened by placing more emphasis on bankruptcy risks of retail banks; the transfer of existing systemic activities towards less regulated and supervised markets and reputational risk. A better analysis of the borrowing costs for households (impacted by the potential decreasing diversification of the funding base of banks and scarcer liquidity) and implementation costs could help regulators to achieve the objective of efficient household activities.

Was the ECB’s Comprehensive Assessment up to standard? CEPS Policy Brief No. 325, 10 November 2014

The Comprehensive Assessment conducted by the European Central Bank (ECB) represents a considerable step forward in enhancing transparency in euro-area banks’ balance sheets. The most notable progress since the previous European stress test has been the harmonisation of the definition of non-performing loans and other concepts as well as uncovering hidden losses, which resulted in a €34 billion aggregate capital-charge net of taxes. Despite this tightening, most banks were able to meet the 5.5% common equity tier 1 (CET1) threshold applied in the test, which suggests that the large majority of the euro-area banks have improved their financial position sufficiently that they should no longer be constrained in financing the economy. As shown in this CEPS Policy Brief by Willem Pieter de Groen, however, the detailed results provide a more nuanced picture: there remain a large number of the banks in the euro area that are still highly leveraged and in many cases unable to meet the regulatory capital requirements that will be introduced in the coming years under the adverse stress test scenario.

An economy with unrealistic indicators: an evaluation of the economic situation in Belarus and a forecast for 2013. OSW Commentary No. 103, 2013-02-20

The macroeconomic results achieved by Belarus in 2012 laid bare the weakness and the inefficiency of its economy. Belarus’s GDP and positive trade balance were growing in the first half of last year. However, this trend was reversed when Russia blocked the scheme of extremely lucrative manipulations in the re-export of Russian petroleum products by Belarus and when the demand for potassium fertilisers fell on the global market. It became clear once again that the outdated Belarusian model of a centrally planned economy is unable to generate sustainable growth, and the Belarusian economy needs thorough structural reforms. Nevertheless, President Alyaksandr Lukashenka consistently continues to block any changes in the system and at the same time expects that the economic indicators this year will reach levels far beyond the possibilities of the Belarusian economy. Therefore, there is a risk that the Belarusian government may employ – as they used to do – instruments aimed at artificially stimulating domestic demand, including money creation. This may upset the relative stability of state finances, which the regime managed to achieve last year. The worst case scenario would see a repeat of what happened in 2011, when a serious financial crisis occurred, forcing Minsk to make concessions (including selling the national network of gas pipelines) to Moscow, its only real source of loans. It thus cannot be ruled out that also this time the only way to recover from the slump will be to receive additional loan support and energy subsidies from Russia at the expense of selling further strategic companies to Russian investors.

On the verge of crisis? Mounting economic problems in Belarus. OSW Commentary No. 51, 2011-04-06

Belarus’s financial condition has visibly worsened since the beginning of this year. The severe falls in the country’s foreign currency reserves and its shortage of foreign currency on the international market pose an increasing threat to the stability of the Belarusian economy. Fearing an outbreak of public dissatisfaction, The government has so far been trying to avoid devaluing the rouble or structural economic reforms. Maintaining full control inside the country and the stability of the authoritarian regime are still the main concerns for President Alyaksandr Lukashenka. For this reason, the actions taken by the Belarusian government have been limited to imposing short-term administrative restrictions on the foreign currency market and obtaining external support in the form of loans. Given Belarus’s falling creditworthiness, Minsk is only able to ask Russia for financial support, thus offering the Kremlin more opportunities to realise its desire to take over strategic industrial plants in Belarus. However, the present economic problems of Belarus are so serious that no loan will be able to safeguard its government from the need of carrying out serious economic reforms.

Systemic crisis in Alexander Lukashenko's regime. OSW Commentary No. 66, 2011-10-28

Measures undertaken by the Belarusian government in the areas of the economy, internal affairs and foreign policy in recent months have proven increasingly ineffective. Despite the deteriorating macroeconomic situation, Minsk is not implementing the reforms necessary to combat the crisis and its activity is limited only to feigned actions and administrative regulations. As a result, the economic situation is worsening but the chances of obtaining external loans as support, for example from the International Monetary Fund (IMF), are decreasing. At the same time there is mounting fear among the regime of social unrest, therefore by raising salaries of the least well-off groups of citizens it is trying to compensate for the increased costs of living. On the other hand, the government is extending the scope of control over society and competences of enforcement bodies. Belarus’s room for manoeuvre in foreign policy has also been diminishing substantially. Despite the EU’s declared willingness to reach an agreement and its encouragement, Lukashenko is not ready to make concessions in the political sphere (e.g. to rehabilitate political prisoners), and this is hindering the normalisation of relations with the West. Minsk furthermore feels a mounting pressure from Moscow, making the Belarusian negotiating position ever weaker. The lack of freedom of manoeuvre in foreign policy, no possibility to maintain a costly economic model and the lack of support from the majority of society all prove that Alexander Lukashenko’s regime is in severe crisis. The system he established is no longer able to respond to current threats with adequate and effective strategies. This situation is challenging the regime’s stability and calls into question its viability in the longer term.

Ukrainian economy on the verge of recession. OSW Commentary No. 96, 2012-11-21

In the third quarter of 2012, Ukraine’s economy recorded negative growth (-1.3%) for the first time since its 2009 economic crisis. Q4 GDP is projected to suffer a further decline, bringing Ukraine into formal recession. In addition to the worsening macroeconomic indicators, Ukraine is also facing a series of concomitant economic problems: a growing trade deficit, industrial decline, shrinking foreign exchange reserves, and the weakening of the hryvnia. Poor economic growth is expected to result in lower than projected budget revenues, which in turn could lead to the sequestration of the budget in December. The decline evident across the key economic indicators in the second half of 2012 brings to a close a period of relative economic stability and two years of economic growth, which had been seen as a significant personal achievement of President Viktor Yanukovych and the ruling Party of Regions. The health of the Ukrainian economy largely depends on the state of the country’s export- -oriented industries. The current economic forecasts for foreign markets are not very optimistic. It is impossible to determine whether the current economic downturn is likely to be merely temporary or whether it heralds the onset of a prolonged economic crisis. The limited capacity to deal with the growing economic problems may mean that Kiev will need to seek financial support from abroad. This is particularly significant with regard to external debt servicing, since in 2013 Ukraine will need to pay back around 9 billion USD, including over 5.5 billion USD to the International Monetary Fund. In order to overcome the recession and stabilise public finances, the government may be forced to take a series of unpopular measures, including raising the price of natural gas and utilities. These measures have been stipulated by the IMF as a condition of further financial assistance and the disbursement of the 12 billion USD stabilisation loan granted to Ukraine in July 2010. The only alternative for Western loans and economic reforms appears to be financial support from Russia. The price for Moscow’s help might however turn out to be very high, and precipitate a turn in Kiev’s foreign policy towards a gradual re-integration of former Soviet republics under Moscow-led geopolitical projects.

Financial Engineering Instruments and their Assessment Under EU State Aid Rules. Bruges European Economic Policy (BEEP) Briefing 26/2013

Financial engineering instruments such as guarantees, loans and equity are increasingly used in public funding of enterprises. These instruments have three attractive features: they are repayable, they “leverage” private involvement, and they have a multiplier effect because they generate new income. At the same time, however, they are technically complex and they are subject to state aid rules. Their assessment under EU state aid rules creates two additional problems. First, under certain conditions financial instruments may not contain state aid. This is when public authorities act as “private investors”. This means that state aid cannot be presumed to exist in all financial instruments. It must first be established through market analysis. Second, when state aid is found to be present it is not always possible to quantify it. For this reason the state aid rules that apply to financial instruments differ significantly from other rules. This paper reviews how financial instruments have been assessed by the European Commission and under which conditions the state aid they may contain can be considered to be compatible with the internal market. The paper finds that by and large Member States have succeeded to design measures that have all been approved by the Commission.

Do agricultural subsidies crowd out or stimulate rural credit institutions? The Case of CAP Payments. Factor Markets Working Paper No. 4, September 2011

In this paper we estimate the impact of subsidies from the EU’s common agricultural policy on farm bank loans. According to the theoretical results, if subsidies are paid at the beginning of the growing season they may reduce bank loans, whereas if they are paid at the end of the season they increase bank loans, but these results are conditional on whether farms are credit constrained and on the relative cost of internal and external financing. In the empirical analysis, we use farm-level panel data from the Farm Accountancy Data Network to test the theoretical predictions for the period 1995–2007. We employ fixed-effects and generalised method of moment models to estimate the impact of subsidies on farm loans. The results suggest that subsidies influence farm loans and the effects tend to be non-linear and indirect. The results also indicate that both coupled and decoupled subsidies stimulate long-term loans, but the long-term loans of large farms increase more than those of small farms, owing to decoupled subsidies. Furthermore, the results imply that short-term loans are affected only by decoupled subsidies, and they are altered by decoupled subsidies more for small farms than for large farms; however, when controlling for endogeneity, only the decoupled payments affect loans and the relationship is non-linear.

The effort to stabilise the financial system in Japan: an outline and the characteristics of the programme for financial revival. Bruegel Working Paper 2015/02, 18 March 2015

This Working Paper provides an overview of the Programme for Financial Revival announced in October 2002 in Japan. The programme aimed to dramatically reduce the large amount of non-performing loans that remained until the end of the 1990s. In addition to solving the problem of bad loans, the Programme for Financial Revival aimed to build a strong financial system. For this purpose, the programme comprised three pillars: 1) creation of a new framework for the financial system, 2) creation of a new framework for corporate revitalisation, 3) creation of a new framework for financial administration. The Japanese experience suggests that despite its delayed introduction, this programme may be considered successful in going some way to drastically reduce non-performing loans and stabilise the financial system. Japan’s financial problems and their resolution since the 1990s provide a number of lessons for other economies, particularly for Europe in relation to the difficulties over the euro.

Living (dangerously) without a fiscal union. Bruegel Working Paper 2015/03

The euro area’s political contract requires member nations to rely principally on their own resources when confronted with severe economic distress. Since monetary policy is the same for all, national fiscal austerity is the default response to counter national fiscal stress. Moreover, the monetary policy was itself stodgy in countering the crisis, and banking-sector problems were allowed to fester. And it was considered inappropriate to impose losses on private sector creditors. Thus, the nature of the incomplete monetary union and the self-imposed taboos led deep and persistent fiscal austerity to become the norm. As a consequence, growth was hurt, which undermined the primary objective of lowering the debt burden. To prevent a meltdown, distressed nations were given official loans to repay private creditors. But the stress and instability continued and soon it became necessary to ease the repayment terms on official loans. When even that proved insufficient, the German-inspired fiscal austerity was combined with the deep pockets of the European Central Bank. The ECB’s safety net for insolvent or near-insolvent banks and sovereigns, in effect, substituted for the absent fiscal union and drew the central bank into the political process.

Contractual arrangements: the overlooked step towards a fiscal union. European Policy Brief No. 18, December 2013

‘Contractual arrangements’ were proposed as an initial step towards a fiscal union that would consolidate the EMU. At this stage, the debate should be centred on the cornerstone of these contracts: the solidarity mechanism. The form of the financial support should not be limited to loans, and include the possibility for grants. Only the countries with the greatest adjustment needs should benefit from the financial support of other countries. This solidarity could be justified in principle by the intensity of the ‘shocks’ they experienced. In this way, contractual arrangement would facilitate the completion of the necessary adjustment in the current crisis – thanks both to more structural reforms and more mutual support within the eurozone.

Towards a balanced contribution of household credit to the economy. CEPS-ECRI Task Force Report, May 2015

While policy-makers are creating conditions to strengthen recovery, the debate on the role that retail finance should play in this respect focuses on corporate loans rather than on household credit. The improvement of financing conditions for firms in order to support further investment spending is certainly essential to ensuring sustainable growth. However, a significant part of EU growth will depend on the behaviour of households and on their ability to secure funding for their consumption and investment. It is therefore essential to place further emphasis on the different options available to stimulate household credit, in particular consumer loans. Nevertheless, in order to avoid past mistakes, regulators should continue to develop a framework where consumer loans (and by extension household credit) contributes to the economy in a balanced way. To achieve this, five main issues need to be addressed further.

The Vulnerability of Europe's Small and Medium-Sized Banks. Bruegel Working Paper 2015/07, 16 July 2015

We study the vulnerability of 130 banks directly supervised by the European Central Bank’s Single Supervisory Mechanism. Illustrative stress tests using banks’ balance sheet data reveal that significant stress prevails in the euro area’s smaller and medium-sized banks, many of them located in southern Europe. The banks we identify as stressed also have performed substantially worse on the stock market. The vulnerable banks are typically hobbled by non-performing loans to European businesses. Strengthening the banking system, therefore, is important to achieve sustainable recovery because it will revitalise credit to the healthier segments of the economy. But instead of emphasising bank recapitalisation, as in past years, we believe the task is to shrink the banking sector to a healthier core.