European Banks - Record Collapse in Loan Demand

The quarterly European Central Bank (ECB) survey was just released, and there were some shocking takeaways, namely that European loan demand has reached a historic low, overtaking levels witnessed during the Global Financial Crisis in 2008.

According to the European Central Bank's quarterly survey of 158 major banks, there has been a sharp decline in demand for loans from businesses in the last three months. Most importantly, this decline is the most significant on record since the survey's inception in 2003.

The decrease in loan demand was much stronger than what banks had anticipated based on the previous quarter's expectations. Small and medium-sized enterprises (SMEs) experienced the most substantial net decrease in loan demand since the survey's inception, with a net percentage of -40%. Demand for loans from large firms also saw a significant decline, though not as severe as during the global financial crisis, with a net percentage of -34%.

The decline in loan demand was primarily driven by rising interest rates and a decrease in fixed investments. Lower financing needs for mergers and acquisitions (M&A) and improved corporate profits leading to available internal funding were additional factors contributing to the reduced loan demand for businesses. Moreover, demand for long-term loans showed the most significant net decrease in the survey's history, nearly halving at -46%, while demand for short-term loans also decreased significantly (-22%), reaching levels close to the historical low of the GFC.

Both SMEs and large firms identified the general level of interest rates and their financing needs for fixed investments as the main reasons for their reduced loan demand.

Although the percentage of banks reporting tighter credit standards decreased compared to the previous quarter, it remained higher than the survey's historical average. While this tightening of credit standards added to the existing substantial restrictions, its impact likely was not as significant as the other economic factors mentioned above.

Demand for mortgages also experienced a sharp drop, although not as severe as in the preceding two quarters. To no surprise, the ECB predicts a further moderate decrease in mortgage demand during the upcoming third quarter.

The survey also indicated that banks were pushed to tighten credit standards due to their stock of non-performing loans (NPL). While NPL ratios did not change significantly, banks' perception of refinancing and repayment risks increased.

Given the tightening credit standards and weakening loan demand, investment activity is expected to weaken further, theoretically aiding the ECB's efforts to control inflation. However, as we have seen time and time again, that doesn’t necessarily mean a positive economic outcome.

Overall, the significant decline in loan demand paints a challenging economic picture for both Europe and the Western world more broadly, as it is likely only a matter of time before this shocking decrease in loan demand, and the preceding factors that caused it, trickle down into other areas of the economy.

Along with the factors discussed yesterday and China’s shocking slow down, there are concerningly increasing signs of a global recession dead ahead.

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