Slow European economy means demand for loans won't pick up for a while yet, ECB head says

FRANKFURT – European banks, flush with cheap credit from the European Central Bank, are making it easier for consumers and companies to get loans — but demand for credit remains very low due to worries over the region’s economic prospects.

The ECB’s closely watched survey of lending practices released Wednesday indicated a substantial thawing of credit conditions among banks since it gave them €1 trillion ($1.3 trillion) in cheap loans.

On paper, that is a hopeful sign for the European economy as it struggles with a crisis over too much government debt.

However, the survey also indicates businesses and households are not applying for that credit because they are concerned about the outlook for the eurozone economy, which is expected to shrink 0.3 per cent this year according to EU forecasts.

In particular, banks said they saw less demand from consumers for mortgage loans and from businesses for credit to expand their plants and equipment. That adds to recent indicators that the eurozone economy remains in weak shape as governments cut back spending to fight the debt crisis.

ECB head Mario Draghi said the survey indicated that restraints on the supply of loans “have decreased considerably,” but that lending was likely to remain subdued “for some time” because of a slow economy.

“We see demand still very, very weak for credit,” he said.

Draghi urged governments to step up their efforts to reform their economies and promote more growth.

He said Europe needed a “growth compact,” echoing his earlier call for a “fiscal compact.” That call was met when European governments agreed on a treaty tightening rules on spending. But he didn’t specify what the growth compact would consist of.

The ECB bank lending survey showed that far fewer banks had tightened their loan standards in the first three months of the year compared with last year. Of 131 surveyed banks, only a net 9 per cent said they had made their lending practices tougher.

That’s a significant improvement from a net 35 per cent that tightened credit in the fourth quarter of last year, when markets were seized with fear that a large eurozone country such as Spain or Italy might default on its debts. That feared financial collapse didn’t happen, and market conditions improved after the ECB made huge amounts of cheap credit available to banks on Dec. 21 and Feb. 29.

The ECB’s massive loans supplied banks with plentiful cash, many of them small banks that loan to the small and midsize companies that provide most eurozone jobs. That means “central bank lending has come very close to the real economy,” Draghi said.

But the money won’t reach businesses and consumers until they see a reason to ask for it. Demand for loans from both businesses and households remains low, a fact the ECB cannot directly affect through its monetary policies.

“We cannot replace the lack of demand,” Draghi said before the European Parliament’s committee on economic and monetary affairs.

He declined to say if the bank would make more cheap long-term loans to banks. “We never precommit,” he said.

The ECB’s loans, handed out in two batches to banks on Dec. 21 and Feb. 29, are credited with ensuring banks had enough funds to operate and removed fears of a bank collapse that could have further shaken the eurozone. However, the calming effect on markets has evaporated in recent days, with investors demanding higher interest rates to loan money to Spain and Italy.

The increasing market tensions have led to calls for the ECB to do another series of loans, dubbed longer-term refinancing operations, or LTROs. Draghi and other ECB officials however have stressed that it’s up to governments to reduce their deficits and improve prospects for growth by cutting excess regulation that discourages hiring and starting businesses. They say the LTROs only gained governments time to do that.

Commerzbank economist Michael Schubert said the easier credit conditions “probably confirm the ECB council members’ view that for the time being there is no need for a further long-term tender operation.”