–Adds details on funding constraints, credit conditions, loan demand

FRANKFURT (MNI) – Banks unexpectedly tightened credit standards in
the second quarter, as the sovereign debt crisis affected their ability
to obtain funding even while the economic recovery sparked a pick-up in
demand for loans, the European Central Bank said in its July Bank
Lending Survey (BLS), released Wednesday.

Looking ahead, banks expect continued constraints on wholesale
funding access.

“In the second quarter of 2010, negative spillover effects from the
sovereign debt crisis appear to have worsened banks’ ability to obtain
funding. Hence, banks reported that access to wholesale funding became
more difficult compared with the first quarter,” the ECB said.

In the third quarter, “banks expect that the current difficulties
in accessing wholesale funding will remain, although not to the same
extent as observed in the second quarter of 2010,” the central bank
added.

News of tighter credit standards is a disappointment, especially
since banks had previously projected unchanged credit standards in the
second quarter for both businesses and households, and more recent
developments had pointed to easing tensions on money markets.

Coupled with the stronger-than-expected recovery reflected in a
pick-up in loan demand, the data may also raise concern about credit
conditions weighing on economic developments in the months ahead.

Details on banks funding difficulties showed that in the second
quarter about 30% to 40% of the banks surveyed reported impairment of
their access to money markets and around 40% to 50% of the banks
reported deteriorated access to debt securities markets. There was also
a decline in access to securitisation of corporate loans and loans for
house purchases as well as synthetic securitisation, the report showed.

“Regarding the impact of the financial turmoil on banks’ costs
related to their capital positions and on their lending policy, there
was only a very slight change between the first and the second quarters
of 2010,” the report said. Survey results showed that about 40% of the
reporting banks indicated “some” or a “considerable” impact on both
capital and lending.

Looking at credit conditions for enterprises in particular, the ECB
said that “net tightening of credit standards on loans to enterprises,
which came to a halt in the first quarter of 2010, was reversed in the
second quarter, increasing from 3% to 11%.” Looking forward, euro area
banks anticipate credit standards on loans to enterprises to tighten
somewhat in the third quarter of 2010 (by 5%).

The degree of net tightening of credit standards on loans to
households for house purchase was unchanged at 10%, exceeding the 2%
expected for the second quarter at the time of the previous survey.
“Similarly, the degree of net tightening remained broadly unchanged for
consumer credit, at 12%, compared with an expected 2% in the previous
survey round,” the report said.

In contrast to business credit conditions, “banks expect a decrease
in the net tightening of credit standards for loans for house purchase
and consumer credit in the third quarter of 2010, to 3% and 6%
respectively.”

Demand for loans, on the other hand, picked up for both enterprises
and households as the Eurozone’s recovery continued.

“While credit supply conditions deteriorated, the July 2010 BLS
results pointed to a gradual improvement in the net demand for loans in
the second quarter of 2010, being only slightly negative for loans to
enterprises and turning positive for loans to households,” the report
said.

“The most important reason for higher net demand for loans by
enterprises was a less negative contribution from factors such as fixed
investment and mergers and acquisitions. Moreover, the negative
contribution from substitute sources of financing became somewhat less
pronounced in the second quarter,” the ECB said.

Nevertheless, results disappointed on business loan demand. In the
previous bank lending survey, banks had forecast positive net loan
demand for enterprises in the second quarter. Banks now expect a further
pick-up in the third quarter.

“For housing loans, demand turned positive after its slightly
negative levels in the previous quarter. This increase in net loan
demand was due mainly to improved housing market prospects, higher
spending on durable consumer goods and a less negative contribution from
consumer confidence,” according to the ECB survey.

The survey was conducted from June 14 through July 2 2010 on a
sample group of 120 euro area banks. The response rate was 100%, the ECB
said.

The release of the survey follows the publication Tuesday by the
ECB of June’s M3 lending data, which appeared to send more encouraging
signals. The M3 data showed June mortgage lending rising at the fastest
pace in almost two years, raising hopes that bank lending in the
Eurozone may be on the path to recovery.

European bank stress test results published last Friday also
signaled that the Eurozone’s banking system is in relatively sound
shape, authorities have said, suggesting that the economic recovery
should not be constrained by a credit crunch.

Critics of the tests, however, argue that the criteria used were
too soft to detect problems.

Today’s ECB data show that while the banking system may be on a
recovery path, it is certainly not healthy enough to resume regular
lending activity, suggesting that credit conditions might yet dampen the
recovery.

–Frankfurt newsroom +49 69 72 01 42; e-mail: jtreeck@marketnews.com

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