The Review of Financial Studies

What information does the euro area bank lending survey provide on future loan developments?

Retrieved on: 
Monday, January 16, 2023

The *euro area bank lending survey (BLS) * provides valuable information on bank lending standards and conditions as well as on loan demand in the euro area.

Key Points: 
  • The *euro area bank lending survey (BLS) * provides valuable information on bank lending standards and conditions as well as on loan demand in the euro area.
  • *By collecting this information, the survey sheds light on the transmission of monetary policy in the euro area via the bank lending channel.
  • While the survey information is qualitative, the replies of the banks are closely related to actual loan growth and lending rate developments.
  • *BLS data provide timely information on bank lending conditions and loan demand.
  • The short reporting lag compared with other statistical data means that BLS data provide early information on key lending developments in the euro area, which has been especially valuable for identifying turning points in lending conditions and assessing lending developments during exceptional periods.
  • [4] Overall, the BLS has proved to be a very useful tool for understanding and analysing bank lending conditions in the euro area.
  • A first indication of the information BLS indicators provide for future loan growth is to consider cross-correlations between BLS indicators at different leads relative to data on actual loan growth.
  • BLS indicators either lead loan growth (negative value on the y-axis) or lag loan growth (positive value).
  • Beyond the simple correlations mentioned above, the information that the BLS indicators provide on future loan growth can be assessed by analysing their value in forecasting actual loan growth.
  • Broadly corresponding evidence on the information that the BLS provides regarding future loan growth is also found for individual euro area countries.
  • The BLS contains information on future loan growth not only at the aggregate level, but also for individual banks.
  • Loan demand also helps predict future housing loan growth at the bank level – banks reporting a decrease in demand experience lower loan growth over the following quarters compared with banks reporting unchanged or increased loan demand (Chart D, panel b).

Model-based regulation: lending in times of Covid

Retrieved on: 
Monday, January 16, 2023

This is because during upswings in the business cycle banks tend to overestimate the creditworthiness of their borrowers, often resulting in excessive credit expansion, while they rapidly cut lending during downturns.

Key Points: 
  • This is because during upswings in the business cycle banks tend to overestimate the creditworthiness of their borrowers, often resulting in excessive credit expansion, while they rapidly cut lending during downturns.
  • In our recent paper (Fiordelisi et al., 2022), we focus on the impact of model-based regulation on lending during the pandemic.
  • This could exacerbate procyclicality, worsen the economic downturn and potentially have negative consequences for the overall stability of the banking sector.
  • For example, there are model parameters specifically designed to increase banks’ resilience during economic downturns that should support lending during such times.
  • While the trends in lending for the two groups were largely comparable before the pandemic, after March 2020 IRB banks cut lending significantly compared with SA banks.
  • Loans to non-financial corporations (NFCs)

    Notes: “SA banks” are banks reporting all corporate credit risk exposures using a standardised approach.

  • Banks that include these features in their models continue to provide credit to the corporate sector in bad times, thereby also supporting the economic recovery.
  • (2016, 2022) which show that in Germany, model-based risk estimates systematically understated actual default rates and had a procyclical effect.
  • model-based regulation) aims to ensure that an increase in risks is swiftly taken into account, which supports the financial soundness of individual banks.
  • At the same time, the use of these models generally induces lower lending to firms during crises.

Side effects of monetary easing in a low interest rate environment: reversal and risk-taking

Retrieved on: 
Friday, November 11, 2022

Since 2014, the European Central Bank (ECB) and other central banks have been pursuing a negative interest rate policy (NIRP).

Key Points: 
  • Since 2014, the European Central Bank (ECB) and other central banks have been pursuing a negative interest rate policy (NIRP).
  • The controversy about monetary policy in a low rate environment hinges on the existence of a zero-lower bound (ZLB) on interest rates (Coibion et al., 2012).
  • In a low or negative interest rate environment, it becomes harder for banks to pass on the reduction in the policy rate to their depositors.
  • This means a policy rate cut translates into a lower interest rate margin and reduces the net worth of banks.
  • In our recent paper (Heider and Leonello, 2021), we present a simple conceptual framework to show how a policy rate cut affects both bank lending and risk-taking in a low or negative interest rate environment versus a high interest rate environment.
  • The substitutability between loans, deposits and bonds is the channel through which the policy rate affects loan and deposit rates.
  • Reversal occurs when a cut in the monetary policy rate reduces lending instead of increasing it (Brunnermeier and Koby, 2018).
  • The level of the policy rate at which lending is maximal identifies the reversal rate.
  • Reversal is related to but not directly triggered by reduced profits from a contraction in the net interest margin at the ZLB.
  • This implies that when the policy rate falls below the reversal rate, a policy rate cut leads to increased risk-taking.
  • With market power, an increase in the lending volume reduces the loan rate, which then further reduces the benefit from screening.
  • Our research suggests that there are potential side effects of monetary stimulus in a low interest rate environment: reduced lending and increased risk-taking by banks.

Low rates and bank stability: the risk of a tipping point

Retrieved on: 
Friday, November 11, 2022

This has spurred academic and policy discussions about the economic implications of such low rates for the banking sector.

Key Points: 
  • This has spurred academic and policy discussions about the economic implications of such low rates for the banking sector.
  • It develops a model closely based on Allen and Gale (1998) and shows the existence of a critical policy rate level, dubbed the tipping point.
  • Past the tipping point, an interest rate cut has a negative net effect on bank capital and may indeed result in bank insolvency.
  • From the model, we learn which bank characteristics matter for the tipping point and how they affect it.
  • Using these theoretical results, we can use data on banks to quantify the tipping point.
  • To discuss bank solvency, we need to understand what constitutes the assets of a bank from an economic point of view.
  • A banks deposit franchise, which is generally not capitalised on bank balance sheets, is also a relevant bank asset.
  • With this concept of solvency in mind, the question becomes: what is the effect of a low policy rate on bank assets?
  • Past the tipping point, the deposit-franchise effect dominates and a policy rate cut hurts bank solvency.
  • Our observed value for average bank asset maturity (4.5 years) implies that a 0.55% policy rate is the tipping point.
  • [4]
    More work is required to obtain a sound quantification of the tipping point, also for the euro area.

Monetary and macroprudential policies: trade-offs and interactions

Retrieved on: 
Friday, November 11, 2022

Hence, macroprudential policies should be used appropriately to manage the balance between deeper recessions and longer-term benefits for economic growth.

Key Points: 
  • Hence, macroprudential policies should be used appropriately to manage the balance between deeper recessions and longer-term benefits for economic growth.
  • Generally, the instruments of monetary policy and macroprudential policy both operate through the financial system.
  • For instance, Van der Ghote (2021) argues that (conventional) monetary policy interventions and macroprudential policy interventions can both help to safeguard financial stability.
  • In this situation, the degree of monetary policy accommodation is key to smooth the negative effects of tighter macroprudential policy (see Chart 3).
  • Accommodative monetary policy is shown by the black solid line, a constrained monetary policy is shown by the red dashed line.
  • Macroprudential policy can also have an impact on the transmission of monetary policy.
  • The interaction of monetary policy and macroprudential policy also affects bank lending, resulting in strong complementarity between the two policies (see Altavilla, Laeven and Peydr, 2020).
  • The effects of monetary policy easing on bank lending and risk-taking are greater when macroprudential policy is accommodative and are particularly strong for less capitalised banks.
  • Overall, monetary and macroprudential policies cannot be considered in isolation, as their transmission channels give rise to significant spillovers.
  • The degree of monetary policy accommodation has an effect on the short-term impact of macroprudential policy and therefore on the macroprudential policy space.
  • Recent research developed within the ECB Research Task Force on monetary policy, macroprudential policy and financial stability shows that monetary and macroprudential authorities must take account of important trade-offs and interactions when deciding on policy actions.
  • Substantial progress has been made on developing practical frameworks of analysis to assess the costs and benefits of macroprudential and monetary policy interventions.

Europe's growing league of small corporate bond issuers: new players, different game dynamics

Retrieved on: 
Friday, November 11, 2022

In the eurozone since 2008, aggregate market financing has been growing significantly faster than bank lending.

Key Points: 
  • In the eurozone since 2008, aggregate market financing has been growing significantly faster than bank lending.
  • Policymakers have supported the increase in bond financing as it can help insulate firms from shocks to the banking sector by diversifying sources of funds.
  • These new players are considered key to achieving a transition from a largely bank-based system towards more capital market funding.
  • To this end, in Darmouni and Papoutsi (2022), we have built a large panel dataset, using two decades of micro-data.
  • We have used this to study the European corporate bond markets new players: smaller, private, and unrated issuers that have entered the market in recent years.
  • This is important because, while these new issuers embody the shift towards increased capital market funding, they might be "invisible" in aggregate bond market volume or spreads.
  • While bank loans still account for the largest share of corporate debt, euro area firms have increasingly resorted to bond financing, especially following the global financial crisis of 2008-09.
  • This is justified by the number of firms entering the bond market.
  • In March 2020, at the onset of the coronavirus (COVID-19) pandemic, European corporate bond markets were thrown into turmoil.
  • However, our study paints a different picture: it seems that the pullback of bond investors was primarily aimed at the largest, rated issuers.
  • Overall, our paper suggests that the new players in the growing minor league of the European bond market are largely disconnected from the more established, top-division players and still heavily bank-dependent.
  • First, if we rely entirely on aggregate bond market indicators, we might not pick up on what is happening with smaller issuers.
  • Third, interventions aimed at stimulating the bond market might have limited impact on smaller issuers relative to larger, investment grade firms.
  • Overall, looking at European corporate bond markets through the lens of firm-level data reveals striking differences between the major and minor leagues.