The Economic and Monetary Union can be interpreted as a kind of change in the economic regime in as are those of the EMU member states
Theoretical interrelationships are often invalidated if radical changes take place in the real economy or the financial sphere over a short period. The birth of the Economic and Monetary Union is an example of such a fundamental change, which can be interpreted as a kind of change in the economic regime in the European financial marketplace. As it is one of Hungary’s most important objectives to become a member of EMU as soon as possible after joining the EU, it is worth examining the changes that have taken place in the Euro-pean bank loan market over recent years, and especially to see whether the change in economic regime has had any impact on lending cycles. Naturally, these events are too recent to allow firm conclusions to be drawn. Presenting the initial experiences, how-ever, may be useful, especially because the Hungarian financial market is characterised by the dominance of banks, as are those of the EMU member states. Therefore, analysing the developments in the lending market may yield a number of useful lessons.
The important economic role of loans in the European Union is demonstrated by the statistics of the ECB (2000), which show that the ratio of banks’ corporate lending to firms expressed as a percent-age of GDP was 45.2% in 1999, while the figure for corporate bonds was only 7.4%. In the USA these ratios were 12.6% and 29%, respec-tively. In other words, banks’ role in financing the economy is much greater in Europe than in the USA. The balance sheet total-to-GDP ratio is further evidence of this, being 175% in the euro area, com-pared with just 99% in the USA.
The way in which
In line with the earlier remarks, the ECB (2000) points out that the way in which monetary policy exerts its influence and the effi-ciency of transmission both strongly depend on developments in de-mand and supply and structural factors in the banking sector. These latter include the level of competition, the preferences for the maturi-ties of loans and deposits, the adjustability of interest rates, the vari-ous risk premia, as well as administrative regulations and costs.
Household and corporate sector borrowing rates follow the trends of market rates fairly closely, although the variability of bank rates is much lower; consequently, the smoothing effect mentioned earlier is observable here as well.
The primary external source of finance for non-financial corpo-rations operating in countries of the euro area is bank loans, al-though the role of bank lending has fallen somewhat in the past de-cades.7 A large proportion of loans are long term – nearly 70% of them are for periods of more than one year, and the original maturity of more than a half of all loans is longer than 5 years (ECB, 2001a, Table 2).
7At this juncture, it should be noted that if the structure of financing shifts gradually away from bank loans to equity and bond financing in a country, then the emphasis on wealth effects within the consequences of monetary policy actions will be greater. The explanation for this is that changes in interest rates affect the prices of financial and real goods, and through the wealth effect, firms’ and households’ creditworthiness as well.
Table 2 Financial structure of non-financial corporations*
Per cent
Euro-area USA Japan
1997 1998 1999 1999 1999
Liabilities 100.0 100.0 100.0 100.0 100.0
Loans 30.0 27.2 23.3 5.4 38.9
Trade credit and advance payments
re-ceived 10.7 9.8 8.3 7.8 12.4
Securities other than shares 3.1 2.8 2.4 10.6 9.4
Shares and other equity 51.7 56.3 62.6 70.2 33.8
Other liabilities 4.5 3.9 3.3 6.1 5.5
Source:ECB (2001c)
* Debt securities and shares are valued at market prices.
Convergence towards EMU has promoted the expansion of lend-ing
Taking into account that the prices of debt securities and shares rose significantly in the period 1997–1999, the table obscures the fact that there was a robust increase in loan and bond liabilities in volume terms. Although the revaluation effect reduced substantially the weight of loan and bond liabilities within total liabilities, the ratio to GDP of non-equity borrowing actually rose. Lending growth fluc-tuated around 10% in the period under review, which, after taking in-flation into account, corresponds to a very significant real increase of some 7%–8% (ECB, 2001a). There were a number of factors behind this high rate. The majority of these were linked to the change in eco-nomic regime – EMU convergence brought about low interest rates and a favourable economic environment in the region, together with increased M&A activities, all of which contributed significantly to an expansion in lending. At the same time, however, one-off factors also had an influence on the overall picture, in particular the financ-ing requirements of UMTS licences, which also caused a consider-able lending expansion.
According to the ECB (2001a), EMU convergence brought real interest rates down to around 4% by the end of the 1990s, creating favourable conditions for borrowing. However, economic growth ta-pered off in the second half of 2000, and real interest rates rose above 5%. As a consequence, lending activity also fell somewhat.
Calza et al (2001) demonstrate that economic growth and the real interest rate level taken together are good explanatory variables of developments in real lending in the euro area, and their model based on this finding provides a good description of the fluctuations in lend-ing within the EU.
However, since the birth of EMU the expansion of lending has exceeded the level forecast by their model, despite falling a little.
Some of the reasons for this are the pick-up in corporate investments outside the EU, for which, in a number of cases, banks provide the finance, and the increase in property and land prices, in addition to the telecommunication projects already men-tioned.
The procyclical be-haviour of bank lend-ing is characteristic in the European Union as well
The slight drop in lending has affected the various economic sectors unevenly. Whereas annual growth in corporate borrowing re-mained above 10% in 2000, growth in consumer credit and housing loans declined, in line with the theory discussed earlier. The decline in demand for housing loans can be explained partly by rising inter-est rates and partly by a slower increase in property prices. All these developments show that the procyclical behaviour of bank lending is characteristic in the European Union as well. However, in its early stages EMU, which can be regarded as a change in the economic re-gime, helped prevent the decline in economic growth from leading to a large-scale contraction of bank lending.
The changes in re-gimes can also include changes in terms of banking regulations…
… including the cre-ation and
wide-spread use of standardised interna-tional capital regula-tions
Nevertheless, the changes in regimes affecting financial mar-kets need not only be macroeconomic by nature, but can also in-clude changes in the regime in terms of banking regulations. Such a process resulting in sweeping changes was the liberalisation of fi-nancial markets in the 1970s and 1980s, which led to considerable credit expansion. However, the creation and widespread use of standardised international capital regulations can also be interpreted as a change in the economic regime, being a kind of coun-ter-reaction to the operational problems of liberalised financial mar-kets. The next chapter is an overview of the impact of these regula-tory changes on banks’ lending activities.