Low supply and demand for credit among banks during corona crisis

Erasmus School of Economics

The chief economist of the European Central Bank (ECB) is concerned about the supply and demand for credit among banks and sees worrying signs. But are these concerns really justified? Casper de Vries, Professor of Monetary Economics at Erasmus School of Economics, gives his view on the current situation of banks in the corona crisis during an interview with newspaper De Volkskrant and Dutch radio station BNR Nieuwsradio.

The ball is in the government's court

‘The interesting thing is that the demand for credit is also low,' says de Vries. ‘This can partly be explained by the current situation in the economy, but on the other hand, the supply is also stagnating. This is simply due to the policy of the ECB which is constantly lowering interest rates so that the margins that banks have are getting smaller and smaller.’ The question is now whether the ECB should do something about this or whether governments should try to stimulate demand more. According to de Vries, the ball is in the governments' court. ‘The only thing the ECB could do is to impose even easier conditions on the loans they grant to banks.’ In any case, the ECB should not push interest rates any further. This would make lending even more unattractive to banks. Furthermore, the low interest rates stimulate the accumulation of debt by companies in order to finance acquisitions. The effects on the market are significant as well: the prices of stocks and real estate are continuously increasing. De Vries: 'Eventually, this will have to end with a huge blow'.

Countries could stimulate demand for loans through new initiatives, says de Vries. ‘It is precisely by stimulating new initiatives that SMEs could be given more room to invest, because then the number of orders would increase.’

The curse of bad loans

Nevertheless, many banks fear payment defaults and bad loans. This was a huge problem in the previous crisis. Could this also become a problem this time? According to de Vries, this is still unclear. ‘In the previous crisis, the problems all came at once because the banks themselves were already in trouble. Now everything is happening in slow-motion. In the beginning, there were very few bankruptcies due to all the government support measures. Now this is starting to build up and more and more things are starting to go wrong.’ According to de Vries, looking ahead is very important, but at the same time very difficult because it is still unclear whether the vaccine can ensure that the economy can recover.

Counterproductive dividends 

However, the banks have entered this crisis in a much better position than the previous crisis. Buffers have been increased and there is stricter supervision. The Dutch Association of Banks have revealed that the percentage of bad loans is around 4%. ‘This is higher than in the previous crisis,' says de Vries. ‘But on the other hand, there is also more capital now. However, there is an enormous tension there because banks may have to take up extra capital because of all the capital that has to be set aside for bad loans. By doing so, they want to show that they are in good shape and can pay dividends.’ This would be counterproductive however, since paying out dividends means that there is less capital available for those bad loans. It is therefore questionable whether it is a smart idea for banks to pay dividends.

Helicopter money

One of the concepts that isn't discussed as much as one might expect, is helicopter money. Whereas the Trump government has already written cheques for every American citizen to combat declining consumption and liquidity, the odds that this policy instrument will be utilized in Europe are highly unlikely. In the treaty of Maastricht, permanent monetary financing is prohibited. However, with regards to this rather formal objection to the use of helicopter money, De Vries sees a more practical problem: 'The ECB is already quietly implementing the monetary funding of governments by purchasing debt. Mainly southern European countries profit from these measures'. One of the problems with this policy is political opinion. According to De Vries, it is getting increasingly difficult to reverse the current policy decisions, since Italian politicians are suggesting the idea to eternally keep the acquired debt on the balance of the ECB.

Professor
More information

The full item from BNR Nieuwsradio, 30 November 2020, can be found here (in Dutch); the article from De Volkskrant, 10 December 2020, can be read here.

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