The post-2007 Eurozone economic crisis has taken on a number of forms. Real economic activity has declined, in certain cases significantly. Turmoil in sovereign and financial sectors has seen yields on government bonds and spreads on bank credit-default swaps (CDSs) increase dramatically. The vast credit expansion of the previous decade has led to large private sector debt overhang.
Concurrent with these crises, lending to the private sector has fallen substantially. An ongoing debate centres on whether this decrease has been driven by weak demand on the part of firms, or on the tightening of credit conditions (the often-heard ‘credit crunch’). A number of papers have identified distinct supply- and demand-side channels and shown that, since the onset of the crisis, supply-side problems have contributed to lower aggregate lending (see, for example, Jimenez et al 2012 and Puri et al 2011). A supply-side credit crunch poses a number of concerns for policy makers. Campello et al (2010), for example, show that credit-constrained firms are less likely to expand employment, invest in technology, or spend on marketing.
While the current crisis has been shown to be associated with an increase in supply-side credit problems, no paper up to now has identified the macroeconomic aspects of the crisis that have led to changes in the supply and demand for credit. Disentangling these different channels is the primary aim of our recent research (Holton et al 2012). This has been made possible by a comprehensive new survey by the European Central Bank known as the Survey of Access to Finance of Small and Medium Enterprises (SAFE). This provides data on 24,000 small and medium enterprises (SMEs) across 11 countries in the four six-month time periods in 2009 and 2010. The time and country variation in the data allows us to delve beneath the surface of the crisis and identify the drivers of credit demand, supply, and conditions at the firm level. We focus in all instances on bank loans, as banks have been shown to be the key source of financing for SMEs (Beck et al 2008).
Our measure of credit demand is an indicator variable for a firm’s need for bank loans decreasing during the period. We measure credit supply using information on whether a firm’s loan application was rejected, or the firm received less than 75% of its desired amount. On credit conditions, we use an indicator for an increase in the interest rate charged on the firm’s loans, and for whether the size of loan available to a firm had increased.
The macro factors for each country, delineated into our three aspects of the crisis described above, are the growth rate of real GDP (real economy), the ten-year sovereign bond yield, median bank CDS spread (sovereign/financial), the ratio of private-sector bank credit to GDP, and the level of debt to output for each of the main sectors included in the survey (debt overhang).
Our chief finding relates to the notable impact of debt overhang on all aspects of SME financing (supply, demand, and lending conditions). This finding echoes the fears of contributors such as Reinhart and Rogoff (2009) that the current economic crisis is notably different from a typical business cycle recession in that significant balance-sheet problems in all sectors of the economy are impeding recovery. Given these fears, Rogoff (2011) has referred to the current crisis as the ‘Second Great Contraction’.
We also find that a weaker real economy is associated with lower credit demand, but do not find a robust impact of sovereign and financial factors on demand. The real economy is also shown to not impact supply or credit conditions. Our results indicate that financial variables such as sovereign bonds and banks’ CDSs, which affect banks’ funding positions, have an important impact on SME financing, and this is isolated as a supply-side problem. This provides direct evidence of a micro-level lending channel through which sovereign and financial problems can exacerbate and prolong recessions by affecting firms in the real economy, over and above any observed effect on demand for financing.
Policy conclusions
Low private-sector credit provision, usually leading to low investment on the part of firms, can be driven by either weak demand or tight supply conditions. A detailed understanding of the effects of specific macroeconomic components of the current European crisis on credit can provide clarity to policymakers and practitioners in planning for recovery.
Our uncovering of distinct effects of the sovereign/financial and real economic crises, with the former affecting credit supply and conditions and the latter affecting credit demand, provides important insights. Our findings confirm the importance of sovereign bond yields for bank loan supply, as they are the primary source of collateral in the interbank market and widely held by banks. This illustrates a possible impairment in the monetary transmission mechanism that is affecting firms at a micro level (González-Páramo 2011). Our findings suggest economies that suffer for the most part in the financial or sovereign sector can elicit large gains in credit provision to the real economy from dealing with these supply-side problems. On the other hand, economies with stagnant real economy growth are likely to see continued depressed credit demand, regardless of improvements in the financial sector.
Our finding that debt overhang affects all aspects of the SME credit market suggests that those countries in which the private sector accumulated large volumes of debt in the pre-crisis era are unlikely to experience increased credit flows to the real economy until these debt levels have been reduced significantly.
References
Beck, T, A Demirgüç-Kunt, and V Maksimovic (2008), “Financing patterns around the world: Are small firms different?”, Journal of Financial Economics, 89(3):467–87.
Campello, M, JR Graham, and CR Harvey (2010), “The real effects of financial constraints: Evidence from a financial crisis”, Journal of Financial Economics, 97(3): 470–87.
González-Páramo, JM (2011), “The ECB’s Monetary Policy during the Crisis”, Closing speech at the Tenth Economic Policy Conference, Málaga, 21 October.
Holton, S, M Lawless, and F McCann (2012), “Credit demand, supply and conditions: A tale of three crises”, Central Bank of Ireland working paper.
Jimenez, G, S Ongena, J Peydro, and J Saurina (2012), “Credit Supply versus Demand: Bank and Firm Balance-Sheet Channels in Good and Crisis Times”, Discussion Paper 2012-005, Tilburg University, Center for Economic Research.
Puri, M, J Rocholl, and S Steffen (2011), “Global retail lending in the aftermath of the US financial crisis: Distinguishing between supply and demand effects”, Journal of Financial Economics, 100(3):556–78.
Reinhart, CM, and KS Rogoff (2009), This Time Is Different: Eight Centuries of Financial Folly, Princeton University Press.
Rogoff, KS (2011), “The second great contraction", Project Syndicate, August.
