Negative territory

Mario Draghi delivered his hotly anticipated suite of measures to kickstart the Eurozone’s moribund economy last month and the collective response, at least initially, was positive. 

Chief among the European Central Bank’s objectives was a desire to encourage increased lending to European SMEs. It was a worthy aim.

But the implementation brings us again to the thorny of issue of what to do with banks. On the one hand, the post-crisis era has largely been characterised by increased regulation. Specifically, the Basel III accords have shaped the way banks think about lending, effectively dissuading them from activities which carry substantial capital adequacy requirements.

The result has been a diminution in the amount of leveraged loan issuance to all but the biggest and most stable customers. Small to mid-cap companies were the first to suffer as banks sated what little appetite they had for lending by dining at the table of their largest corporate customers, customers who typically avail themselves of a host of other banking services that provide fee revenue.

Private debt funds have benefited from this trend, of course. The liquidity that has gone out of the market thanks to banks’ retrenchment has been replaced in part by institutional capital.

So it was with wary eyes that the non-bank lending community scrutinised the ECB proposals. The measure that gained most column inches was the ECB’s decision to introduce a negative deposit rate – essentially, banks would be punished for depositing excess capital with the ECB. The ECB hoped, no doubt, to encourage banks to reallocate that ‘spare’ capital to SME lending activities, with a concomitant boost to the European economy which has suffered from contracting lending to the private sector over the last two years.

In addition, the ECB has increased incentives – ‘targeted longer-term refinancing operations’ (TLTROs) – to banks to lend to Europe’s non-financial private sector. Mortgages are excluded.

Will the measures work? Will banks suddenly start issuing reams of new paper to Europe’s SME community? Such an eventuality would pose a genuine threat to the continent’s private debt community which has begun to thrive precisely because of banks’ reluctance to lend.

The answer is that with a ‘new norm’ established post-GFC, (banks becoming more risk averse, the growth of non-bank lending and so on) these measures are highly unlikely to bring about a volte-face of the continent’s banks.

The caricature of European banks being far more conservative and resistant to change than their North American brethren is largely accurate – compare the pace with which the two banking communities have cleansed and refashioned their balance sheets in recent years.

Yet like a supertanker that has laboriously changed course, European banks are unlikely and indeed unable to pirouette back to a period of reckless or at least highly active lending to the higher-risk SME community. The European Banking Authority will scrutinise the capital adequacy ratios of 124 leading European banks this year, having published various stressed scenarios they must be able to withstand. Why risk the ire of the EBA for the sake of a marginally punitive deposit rate at the ECB?

Private debt funds operating in Europe can breathe easily then, at least for the time being. At our recent first anniversary event, hosted by RBS, a key theme was the outbreak of conviviality between banks and private debt funds in recognition that there is ample room in the European economy for both to operate side-by-side. Perhaps Draghi would have been better advised to encourage the further institutionalisation of the European lending landscape.

As The Blackstone Group’s own president Tony James wrote earlier this year, private debt funds don’t present a systemic threat in the way banks do. The development of a healthy alternative lending community in tandem with the cleaning up of the banking one should ultimately achieve Draghi’s aim of a resurgent European economy.