macroeconomic framework and credit cycle in europe

October 2014

Jorge Sicilia

Chief Economist. BBVA Group

Macroeconomic framework and credit cycle in Europe

The current economic context is affecting both the demand and the supply of credit

Changes in demand and supply of loans to enterprises, Euro Area* (net percentages of banks) Source: BBVA Research based on ECB Bank Lending Survey, July 2014

Demand: negatively affected mainly by the lack of fixed investment

Supply: negatively affected by risk perceptions, cost of funds and balance-

sheet constraints

Expectations point to a gradual improvement of demand and supply

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Demand Supply

* Positive values: Easing credit conditions (supply) or positive demand

Why?

Demand: weak cycle and low potential growth

Economic growth, cyclical comparison GDP pc level Initial downturn t=100; Historical: average cycle of recession and recovery since 1950; Latest: 0=2007 but Germany (2008). Source: BBVA Research, World Bank, IMF and Angus Maddison

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Spain

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Latest Historical

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Latest Historical

Cyclical recovery is weak and bumpy (0.0% 2Q and 0.1-0.2% expected in 3Q)

Few measures to increase trend potential growth

Demand stimulus lower than in other developed areas

Italy

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Latest Historical

Demand: a deleverage process far from finished

Debt of the Non Financial Private Sector from the Banking Sector, %GDP Source: BBVA Research, BIS and OECD

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Supply: Weak, in particular in some countries and for some types of credit

Most pressing problem (% answers, by firm size) Source: BBVA Research based on ECB Access to Finance of SMEs, April 2014 Supply constraints are more of an issue in

peripheral economies than in core countries

Supply issues are more relevant in small companies than in large companies

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Large firms, EMU SMEs, EMU Large firms, Spain SMEs, SpainFinding customers Competition

Access to finance Costs of production or labour

Availability of staff or managers Regulation

Other

Are we sure that supply and demand factors are well identified?

Supply and demand are affected by different factors…, What happened in Spain?

Activity declines at some companies, so they no longer have demand for credit

This is a common pattern in Spanish crises

The most promising sectors are those related to exports

There is asymmetric information: some clients have to resort to another financial

entity that does not know them

Projects have higher risk due to the economic situation

Financial fragmentation affects funding conditions. Regulation and supervision

are stricter

Credit Demand

Economic situation and uncertainty: Businesses are not investing

The restructuring affects a limited number of entities, which do not have access to

liquidity

Corporate size is negatively related to reliance on bank credit

Employees per firm size Source: BBVA Research based on BACH and Eurostat

80% 75%63% 63%

20% 25%37% 37%

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Italy Spain France Germany

-250 employees +250 employees

Avg. size 931 Avg.

size 949

Avg. size

1300

Avg. size

1009

Avg. size 7.6

Avg. size 3.8

Avg. size 3.6

Avg. size 3.2

SMEs' exposure to

credit institutions*

25% 28%20%23%

* Liabilities with credit institutions (% of total balance-sheet)

Careful: According to recent history, the flow of new credit improves first, followed by stocks

Average evolution of consumption+investment vs. credit stock (C+I=100 at the through of the cycle, average of crises in Finland, Japan, Norway, Spain and Sweden) Source: Biggs et al (2009)

Average evolution of consumption+investment vs. credit flow (new business) (C+I=100 at the through of the cycle, average of crises in Finland, Japan, Norway, Spain and Sweden) Source: Biggs et al (2009)

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Consumption + Investment (left) Credit Stock (right)

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Consumption + Investment (left) Credit Flow (right)

Spain, Private Sector: New Loans and Repayments (Quarterly figures, EUR mn) Source: Bank of Spain and BBVA Research

Data show that new lending transactions have bottomed in 4Q’13.

Upward trend confirmed in 2014

New lending will exceed repayments (outstanding credit will grow) by end-

2015

In Spain, new loans are starting to increase, albeit gradually

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New Business Repayments and write-offs

France Spain ItalyCommercial policy 0,5 -- --ECB official rate 1,06 1,26 1,1Spread 12 months (12m-Euribor) 0,74 0,66 --Spread EMU (10y-Euribor) 0,24 0,25 --Spread sovereign (10y country-10y EMU) -- 0,14 0,41Firms default rate -- 0,11 0,22

-- Does not differ significantly from zero

Interest rates on new bank lending (%)

(to non-financial corporations, less than 1 million €, less than 1 year) Source: ECB

Determinants of interest rates on new bank lending (to non-financial corporations Source: BBVA Research based on ECB and Bloomberg. Working Paper to be published

Should we think that the Say’s law applies to credit?

Legacy issues also affect credit conditions, in particular in peripheral countries

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Euro Area Spain Italy France

Will ECB policies do the trick?

Alternative finance must be promoted, but it is, in any case, a long term process

Disintermediation is welcome but we must learn from experience: there are

no free lunches

The less regulated shadow banking can bring about nasty surprises (as part of

the financial system did)

Alternative sources of funding should be under similar scrutiny

…Long legislative process (governing law,corporate law, tranparency and

information)

Structural changing to a more balanced funding pattern (including a capital

markets union) will take time…

Adequate regulation and oversight to avoid new sources of vulnerabilities and protect consumers (or inform

them)

A level playing field must be promoted

Today: Spanish issuance in MARF 0.03% of private credit, MAB

capitalization 0.12%, venture capital 0.06% new funds per year…

Long term: a healthy system with alternative sources of funding

In the meantime, we better have a healthy and resilient banking system ready to provide credit when demand

starts

Size matters, probably due to transparency

Long term: It has to be less of an issue but needs to be worked now

To ensure enough credit for the real economy in the years to come

Today: On-the-spot information on the firms matters a lot

Larger firms, more transparency, better competition, level playing field

Financial Regulation: “In medio, virtus”

If regulatory activism continues, the uncertainty will linger and banks will likely factor this uncertainty in their decisions

Time for a regulatory

stay

From regulatory tsunami…

“Just between the two of us” — that “I recently tried to refinance my mortgage and I was

unsuccessful in doing so.” B. Bernanke

Study of cumulative

impacts

New focus

Times are

hard

Coordinated implementation

…To an almost completed

reform

October 2014

Jorge Sicilia

Chief Economist. BBVA Group

Macroeconomic framework and credit cycle in Europe

Demand: a deleverage process far from finished

Debt of the Non Financial Private Sector Source: BBVA Research, BIS and OECD

Total, from all creditors, % GDP Total, from the Banking sector, % GDP

Non Financial Corporations, from all creditors Households Debt, from all creditors

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Recent data on new loans

Total Upto 1M Over 1M Total Housing Consumer Other

Mar-14 -5,8% -9,4% 5,1% -16,7% 22,9% 40,9% 26,5% 0,1%Apr-14 -9,2% -11,1% 2,8% -19,3% 4,4% 3,6% 11,5% -0,3%

May-14 -11,0% -13,2% 4,9% -24,0% 3,8% 4,1% 11,5% -3,3%Jun-14 0,2% -1,6% 10,0% -6,3% 14,8% 26,0% 14,7% 0,1%Jul-14 -6,4% -9,1% 12,4% -21,6% 12,1% 17,7% 16,1% 1,1%

Aug-14 -2,9% -3,4% 5,5% -9,5% 0,2% -3,4% -6,2% 13,5%

Mar-14 -6,6% -9,7% -1,0% -12,7% 2,4% -0,1% 8,2% 3,6%Apr-14 -3,4% -3,5% -2,9% -3,7% -3,2% -5,4% 0,6% -0,6%

May-14 -6,7% -8,0% -6,0% -8,8% -3,4% -6,1% 2,4% -0,7%Jun-14 -5,3% -5,7% -0,3% -7,4% -4,1% -4,5% 1,3% -7,4%Jul-14 -4,1% -3,4% 1,4% -5,1% -5,9% -7,5% 2,9% -8,4%

Aug-14 -6,1% -6,0% -5,0% -6,4% -6,4% -8,0% 6,8% -12,7%Source: ECB, Bank of Spain and BBVA Research

Total Non financial Corporations Households

New Credit Operations

Eurozone

Spain

Alternative finance in Spain

Concept EUR Million Number% Private

Sector Credit % GDPMARF Issuance 381 5 bonds, 16 commercial paper 0,03% 0,04%MAB Market Cap 1.659 24 firms 0,12% 0,16%Venture capital New funds, 2013 872 0,06% 0,09%

Public funds, endowmentFond-ICO Global 1.200 0,08% 0,12%Fond-ICO Pyme 250 0,02% 0,02%Fond-ICO Infraestructuras 250 0,02% 0,02%

Business Angels Investment 2013 63 0,004% 0,006%Crowdfunding Funds 2013 19 0,001% 0,002%Source: MARF, MAB, IEE, Crowdfunding Spanish Association

MAB: Average turnover EUR 25 million SMEs definition: less than 250 persons employed and annual turnover of up to EUR 50 million, or a balance sheet of no more than EUR 43 million

The majority of Spanish SMEs have a limited size

94,5 93,8 93,3 92,282,8

4,9 5,4 5,6 6,514,1

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Italy Spain France EU 27 Germany

Micro (0-9) Small (10-49) Medium-sized (50-249) Large (+250)

Proportion of firms per number of employees (% number of firms in the country) Source: Eurostat, 2009

SMEs’ sources of financing: mainly via banks

SMEs: Funding source used in the last six months (% positive answers) Source: BBVA Research based on ECB Access to Finance of SMEs, April 2014

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Germany Spain France Italy TotalRetained earnings and sale of assetsBank overdraft, credit line or credit cards overdraftBank loanTrade creditDebt securities issuedEquity

Efficiency

Profitability

Innovation

Financial inclusion

Stability

No national fragmentation (ring-fencing)

No arbitrage/ Shadow banking

No delay in economic recovery

In the long term, only an efficient financial system

can be stable

Regulation: New rules should balance efficiency and stability

macroeconomic framework and credit cycle in europe

Economy & Finance