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Crisis impact on European bank balance sheets revealed

During March, the first month in which the coronavirus pandemic made itself felt in Europe, banks’ balance sheets grew substantially. This is a key finding in a new report from Jan Schildbach, analyst, team head at Deutsche Bank Research.

On the one hand, euro-area banks raised enormous amounts of liquidity from the ECB, other financial corporations and non-financial companies. On the other, they just kept a large part of that at the central bank or lent it to other banks and other financial corporations. In addition, banks extended markedly more credit to non-financial firms which likewise stacked up their liquidity buffers to prepare for weaker cash flows as a result of the looming massive recession. The crisis so far had no major impact on banks’ retail business and their holdings of government bonds.

While the repercussions of the coronavirus-induced recession for banks’ profit & loss accounts are just slowly becoming clear, balance sheet data of euro-area institutions already show some large-scale shifts during the month of March. The report from Schildbach focuses on developments between the end of February and end of March, as in this period the pandemic spread rapidly across Europe, most countries went into lockdowns and global financial markets witnessed the greatest turmoil since the financial crisis.

Total assets up substantially

As was to be expected, total assets in the EMU rose substantially in March, by €764bn, compared to only €351bn a year ago. The year-over-year growth rate jumped to 7.8%, from 6.6% in February. However, Schildbach notes that the aggregate masks some important differences between individual countries. By far the largest asset increases took place in Germany (€246bn) and France (€241bn), followed by Spain (€85bn) and Luxembourg (€75bn). In Germany, this was mostly due to higher liquidity reserves at the central bank (€111bn), remaining assets (€74bn, including derivatives) and corporate loans (€23bn). Derivatives volumes may have climbed due to the enormous market volatility in March as well as greater hedging demand from customers. In France, the picture was more diverse, with remaining assets jumping by €122bn and banks lending more to other banks (€68bn). They also held more liquidity at the central bank (€66bn) and lent more to other financial corporations (€40bn) and to corporates (€37bn). But French banks also reduced debt securities holdings (€-31bn) and external, non-euro area assets (€-29bn) considerably. In Spain, the balance sheet expansion was broad based with no single major category standing out. In Luxembourg, most of the rise in asset volumes stemmed from higher interbank loans (€41bn).

Corporate lending in focus

In a major recession, corporate lending is particularly in focus. Non-performing loans and charge-offs will go up a lot over time but initially, stronger loan demand mainly drives up volumes. This time is not different, according to Schildbach, although outstanding figures have not seen a massive jump, at least yet. In the ECB’s bank lending survey, 26% of banks in the euro area reported an increase in loan demand from firms during the first quarter. In Germany and France, this share was much larger (40% and 35%, respectively). A staggering 77% on aggregate (the highest proportion ever) expect demand to improve again in the current quarter, compared with Q1. Overall, loan growth with domestic companies had been sluggish recently, with a robust performance in Germany and France more or less compensated for by shrinkage in Italy and Spain. Now, in March, loan volumes rose in 14 out of the 19 euro countries (and in all of the big four). Growth picked up meaningfully - in the euro area as a whole, from 0.7% to 3.1%.

Schildbach notes it is also revealing to look at the areas where no particular impact was visible. One is household lending, where just a small dent can be detected. Outstanding volumes fell slightly after a steady acceleration in growth over the past two years. The other area is banks’ holdings of domestic government bonds. So far at least, even in countries such as Italy and Spain where banks in past crises had been loading up on public debt, outstanding volumes did not rise materially. Admittedly, this refers only to the net balance and banks may have sold a lot to the ECB of the government paper they had been holding while at the same time may have bought new bonds that were coming to the market. The ECB, through its existing Public Sector Purchase Programme (PSPP), acquired a net €30bn during March, plus an additional €15bn via the newly established Pandemic Emergency Purchase Programme (PEPP), even though the latter might also include some private sector securities.

Funding the enlarged balance sheets

How did the banks fund this significant enlargement of their balance sheets? The report from Schildbach shows that the biggest source was refinancing operations with the ECB, which further eased conditions for the so-called TLTROs in mid-March. In the EMU as a whole, borrowed funds from the central bank surged by €325bn in that single month, accounting for almost half of the rise in total assets. While it was no surprise that, in absolute terms, the big four countries saw the largest increase, only “core” countries such as Germany, France, the Netherlands or Luxembourg witnessed the highest growth in relative terms, of more than 70% month over month.

In France and Germany, deposits from other financial institutions contributed another substantial chunk to the increase in liabilities. On the one hand, these were interbank deposits, which jumped by €56bn in France and €38bn in Germany. On the other, deposits from investment funds and other financial corporations also surged by €60bn in France and €49bn in Germany. On top of that, France was the only major country with a sizeable net inflow of non-financial corporate deposits (€52bn). German banks, by contrast, widened their remaining and external liabilities, by €61bn and €33bn, respectively, which to a large extent mirrored developments on the asset side. Remarkably, as they are banks’ single biggest funding source, household deposits played only a minor role in the growth of total liabilities, essentially across all countries.

Similar trends to across the Atlantic

All in all, Schildbach concludes that balance sheet trends at euro-area banks in March look similar to those in the US where total assets, loans and deposits all soared, too, during the first quarter. In the EMU, most of the rise in total assets took place in the two largest banking markets, France and Germany, but it was stronger than implied by their share in the euro-area banking system as a whole. De facto, many of the changes during March seem to have been the result of banks raising substantial amounts of liquidity primarily from the ECB and other financial institutions, together with a moderate inflow of deposits from non-financial firms, and now they hold this liquidity at the central bank, other banks, and other financial corporations. In addition, banks lent more to non-financial enterprises. In the next few months, this figure is expected to go up as companies’ cash flow may considerably weaken during the recession which should lead to higher indebtedness. Banks may have also prepared themselves for growing financing needs in other sectors. Some part of the balance sheet extension was more of a technical nature as derivative market values increased which often correspond on the asset and the liability side. Not severely affected in a memorable month (but potentially in future) were banks’ business with households, their government bond holdings and their debt issuance.

 

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Cash & Liquidity Mngm in Europe
Evaluating Banks’ Overall Performance
COVID-19
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