How banks’ non-performing loans quota influences lending practice.

Why are some banks tightening up their terms for business loans whilst others are relaxing their criteria? And why are small businesses complaining about being charged higher interest rates than large corporations? A look at some banks’ non-performing loan stocks provides some answers.

According to a survey by the ECB, banks are softening the guidelines for granting loans. However, not all banks are participating. Especially banks with a high stock of NPLs have tightened their conditions.
More relaxed credit rating standards for loans have recently delighted many companies in Europe. According to a quarterly survey conducted by the European Central Bank (ECB), banks in the Eurozone relaxed their internal guidelines and criteria for lending in the second half of 2018. The value taken by the ECB to calculate the banks’ lending behaviour increased by six percentage points in the third quarter and by a further percentage point in the fourth quarter.

However, not all banks are taking this more relaxed attitude, which primarily benefits small and medium-sized enterprises (SMEs). Banks with high volumes of non-performing loans (NPLs) have tightened up their terms for corporate and property loans and they anticipate that this trend will extend to include private loans in the first half of 2019.

European Central Bank monitors non-performing loans in the Eurozone.

Since the financial crisis, the European Central Bank house has kept a watchful eye on NPLs and wants to provide banks with the incentive to sell these “bad loans”.  Behind this, there also lies concern for the economy, if it becomes more difficult for SMEs to obtain credit.

“When we talk about the real economy, jobs and growth, we are mostly talking about small and medium-sized enterprises,” said Danièle Nouy, back then head of the ECB's Single Supervisory Mechanism (SSM), in July 2018. “And unfortunately, as we witnessed during the crisis: SMEs are more vulnerable to changes in the business environment than large corporations.”
According to Nouy, 99.8% of all EU companies are SMEs and generate 60% of the value of this economic region. However, they have found it more difficult dealing with banks as they – unlike listed companies – do not publish regular financial reports. It is therefore more difficult for banks to assess the credit risk. The result: more rigorous lending terms and higher interest rates.
Especially for small and medium-sized enterprises, banks with high NPL portfolios set interest rates high.

Proportion of non-performing loans affects interest rates – especially for small businesses.

SMEs often depend on a principal bank, says Nouy: “Once an SME has managed to develop a good relationship with a bank, it becomes very expensive for this company to change banks.” SMEs are structurally disadvantaged by this dependency.
We see it in the good times: In a corporate survey conducted by the ECB between April and October 2018, 8% of micro enterprises and 2% of small enterprises reported further increases in interest charges for loans.
The situation on the credit market was considerably different for larger companies during the same period: 3% of large corporations surveyed and also 3% of the larger SMEs reported further falls in interest rates.
And we see it in the bad times: In an ECB Working Paper in August 2017, two ECB economists stated that from 2007 to 2015, SMEs had suffered as a result of increasing interest rates. The interest rate premium for SMEs, known as the small-firm financing premium, has, in some instances, been more than twice as high as in times of no crisis. The reasons for this included unstable bank balance sheets and the market power of principal banks over SME customers: banks with high volumes of non-performing loans are increasing their interest rates when lending to SMEs.  
“When banks fall upon hard times and need to recoup losses sustained on one account from another, they look to those account holders who cannot run away so easily,” said Nouy. These include “dependent debtors” – in other words, many SMEs. One more reason why the ECB is determined to make Europe’s banks reduce their non-performing loans volumes faster.
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