The trend of tightening lending standards from European banks is slowing and likely to reverse, and it looks like more credit will become available to the private sector in the coming quarters, but Citi analysts led by Guillaume Menuet still think that Europe is facing a credit-less recovery.

European Central Bank

European banks credit-less recovery

“Although euro area banks have improved their capital positions since 2008-09, the flow of loans to the private sector has been negative since the second quarter of 2012. Most member states have suffered from a credit squeeze, and some have experienced a credit crunch,” writes Menuet. “Gradual improvement in loan demand suggests more banks in some member states will be in a position to extend credit to the private sector.”

There is still a great deal of uncertainty regarding the European Central Bank’s Asset Quality Review (AQR) and other stress tests; non-performing loans are on the rise in some euro zone countries, and the private sector is still actively deleveraging (though the worst has passed, and the extent of current deleveraging is not uniform across Europe). Menuet doesn’t expect flows to start picking up until spring 2014, and even then most likely as a trickle.

Discrepancy for new loans

Menuet illustrates this by showing the discrepancy between lending standards and demand for new loans. Normally, these two factors are inversely proportional (demand for loans goes up as banks loosen standards), but this time it hasn’t happened. Other economic conditions are interfering with what is normally a very close correlation.

european loan standards v demand 0913

European Central Bank not concerned

The ECB is aware of this, but doesn’t seem to regard it as a problem. “Weak loan dynamics continue to reflect primarily the current stage of the business cycle, heightened credit risk and the ongoing adjustment of financial and non-financial sector balance sheets,” the ECB wrote in the introduction to its September statement. This isn’t completely dismissive of the issue, but the ECB isn’t calling for drastic action either, at least partially because the euro zone seems to be recovering in spite of weak loan demand.

“The ECB will likely adhere to forward guidance until the time when the credit picture is no longer a drag on economic activity,” writes Menuet.