Monday, 8 June 2015

No. 1 – Financing in the Euro area: the recourse to financial intermediations and to financial markets

A financial economist, June 2015

Abstract : The financial system provides three main sources to finance the Euro area economy: bank loans, bonds and shares. The amount and distribution of these sources is different across economic sectors. As a consequence of the negative impact of the crisis on the flow of loans, the issuance of securities has significantly increased from 2008 onwards. However, a contraction in the total amount of bonds is also observed since 2013, particularly linked to the process of bank deleveraging. After the second dip of 2012-2013, data for 2014 provide some signs of recovery in the credit obtained by non-financial corporations and by banks. At the same time, the credit received by households and other financial institutions has stagnated since 2011 or 2012. The net issuance of bonds by governments has declined from the peak of 2009 to pre-crisis levels.

1. Introduction

A variety of sources are available for the financing of the economy. Firstly, via organised markets (e.g. issuance of bonds, quoted shares or private placements); secondly, through the interaction of a firm with its stakeholders (i.e. customers, local and national authorities, employees, suppliers, etc.) involving equity, loans or advances. Both these direct financing channels require providers and users of funding to have matching preferences (with respect to liquidity, risk, etc.) and to interact directly with each other. However, this is not always efficient given informational asymmetries, transaction costs and other market imperfections. Consequently, a third channel of financing is provided by financial institutions which provide an intermediation service, connecting the resources of savers and depositors with funding needs and investment opportunities and by adapting the structural features of the savings pool to the structural features of the pools of consumption and investment plans, e.g. via maturity transformation.

This post provides an overview of the credit or financing provided by the financial system to the Euro area economy, both through bank intermediation and through direct market financing. This post is organised as follows. Section 2 presents the financing through bank intermediation in the form of loans. Section 3 reviews direct market financing, both in the form of issuance of bonds and issuance of shares. Section 4 regroups the data in an approach by economic sector.

2. Funding through bank intermediation: loans


Bank loans are one of the main sources of financing for the real economy, but they area also important within the financial sector. Indeed, about half of the loans provided by Euro area banks financed the real economy (€9,500 billion or 110 percent of Euro area GDP) and the other half went to the financial sector and governments (€10,000 billion), including loans to non-Euro area residents, which are, to a large extent, financial institutions based in London, New York and other global financial centres (Chart 1).

Chart 1: Loans by counterparts granted by Euro Area banks (MFIs), outstanding volumes, € billion

Notes: Other financial institutions include insurance corporations, pension funds, and other financial intermediaries. Interbank loans exclude the positions of the banks at the central bank.
Source: ECB: monetary statistics and own calculations.


While loan volumes provide an order of magnitude of the sector composition, the analysis of flows provides a more dynamic picture of the evolution of loans in the run up to the crisis and throughout the different stages of the crisis across sectors (Chart 2).

Since early 2012, net flows of loans to households have stagnated and net flows of loans to non-financial corporations (NFCs) have been negative (i.e. redemptions were larger than new loans). This situation has continued throughout 2014, but a positive trend is observed in loans to non-financial corporations, although net flows of loans remain negative. Interbank lending presents a similar profile to the one of NFCs: negative net flows since 2012 but improving throughout 2014, although it has already turned positive since mid 2014. On the other hand, Euro area banks have started to grant fresh new credit to non-Euro area residents since late 2013 (the positive net flows indicate that new loans exceed redemptions).

Chart 2: Loans by counterpart granted by Euro Area MFIs (excluding the Eurosystem), net annual flows, € billion

Notes: Net annual flows are calculated as new businesses minus redemptions. MFIs: Monetary and financial institutions (banks); NFCs: Non-financial corporations; OFIs: Other financial institutions; ICPFs: Insurance corporations and pension funds. Deposits at the central bank include current accounts, the deposit facility and fixed term deposits.
Source: ECB: monetary statistics and own calculations

Net flows of loans to government used to be negligible because the main source of external financing for governments is the issuance of bonds; however, they gained importance in late 2010 and early 2011 when the crisis impacted sovereign markets. With increasing financing needs and increasing cost for market financing in some countries, public authorities resorted to bank loans as a complementary source of financing. These loans have been repaid thereafter, so that loans to governments have slightly declined since the peak in 2010.

3. Credit obtained through the issuance of securities


The financing provided through bond markets in the Euro area (Chart 3, left-hand panel) has a similar size to the financing provided through bank loans (about €16,400 billion or 190 percent of Euro area GDP). This is the result of a significant expansion in the last decade: between 2006 and 2014, the Euro area bond markets expanded by almost 50 per cent compared to an increase in bank loans of only 12 percent during the same period; the expansion was particularly intense between 2006 and 2009.

Chart 3: Securities issued by Euro Area residents, outstanding volumes, € billion
Bonds                               Quoted shares

Notes: Other financial institutions include insurance corporations, pension funds, and other financial intermediaries. MFIs: monetary financial institutions.
Source: ECB: securities statistics and own calculations.

With a market capitalisation of €6,000 billion by the end of 2014 (Chart 3, right-hand panel), Euro area equity markets are three times smaller than both bond markets and the financing provided through bank loans. The value of equity was particularly hit by the crisis. Two episodes of value erosion are observed in 2008 and in 2011. Despite the subsequent recovery (and significant issuance of equity throughout the crisis), market capitalisation is only about to reach 2007 levels. In this regards, banks' shares, and the shares of financial institutions in general, were more significantly hit by the crisis (e.g. banks' shares lost 65 per cent of their value between 2006 and 2008) than the shares of non-financial corporations (e.g. they lost 35 per cent of their value in the same period).

Besides the differences in the overall size, the volume of bonds and shares differs significantly in their sector composition (the sector composition of loans is also very different to the one of bonds and shares). Bonds issued by non-financial corporations represent a tiny 6.5 percent of the total and the rest is distributed almost evenly between the financial sector (MFIs and other financial institutions) and governments. On the other hand, NFCs issue the bulk of quoted shares (over 80 percent), while the market capitalisation of banks and other financial institutions is much smaller.


3.2.1. Totals

While the outstanding volumes of bonds are three times larger than the volume of shares (see Chart 3), the difference is amplified to 10 to 1 in terms of flows. For instance, in the peak of 2009, Euro area residents issued €1,500 billion of bonds while in the peak of 2010 they issued €110 billion of quoted shares (Chart 4, note the use of two scales). This is linked, on the one hand, to the fact that equity is usually permanent while bonds have a given maturity and, on the other, to a general trend of increasing use of debt and leverage.

Chart 4: Issuance of securities by Euro Area residents, net flows, year to date, € billion

Source: ECB: Securities statistics and own calculations.

The financial crisis triggered losses and spending in different sectors including the financial sector, public sector and non-financial corporations. This led to increasing financing needs, which translated in the issuance of significant amounts of securities in the markets between 2007 and early 2010 (Chart 4). This boom in the issuance of debt was to be added to the significant amounts already accumulated in the run up to the crisis (see also Chart 3, left-hand panel). A consensus was built about the need to decrease the level of indebtedness and to deleverage, which means increasing own resources (equity) and decreasing debt. Those dynamics explain the latest developments observed since early 2013: issuance of equity soared and issuance of bonds declined to even become negative (redemptions exceeding gross new issuances). In the year to December 2014, Euro area residents issued almost €100 billion of fresh equity (in net terms) and redeemed €200 billion of bonds (in net terms).

3.2.2. Breakdown by sector

The issuance of bonds has compensated, at least partly, the financing gap springing from the collapse of the loan markets reported in Section 2. However, the migration from bank loans to market financing has mainly occurred within the financial system itself as the use of bonds by non-financial corporations is rather limited. Net annual issuance of bonds by governments soared from about €150 billion before the crisis to €750 billion in late 2009. Subsequently, they have stabilised at an annual net issuance of around €250 billion (Chart 5), similar to pre-crisis levels.

The decline in the net issuance of bonds by banks accelerated in 2013 with very large negative net flows. Banking is the sector that is more clearly deleveraging. According to the ECB , market turmoil constrained banks to reduce their issuance of bonds. Data suggest that this was mainly the case for medium-size and small banks but not for the largest banks . The significant reduction in the net issuance of bonds by other financial institutions observed since 2009 can be explained, to a large extent, by the reduction in the securitisation activity (see European Commission, 2015, p. 77). Since 2010, the series have fluctuated around zero.

Chart 5: Bonds issued by Euro Area residents, net flows, year to date, € billion
Notes: MFIs: monetary financial institutions; OFIs: other financial institutions; NFCs: non-financial corporations.
Source: ECB: Securities statistics and own calculations.

Net issuance of bonds by NFCs is much lower than the one of the three other sectors. However, it has significantly increased with respect to the pre-crisis period and stands at levels last seen after the bursting of the dotcom bubble. A substitution effect in favour of direct bond issuances by NFCs is observed since the early 2009 and still continues. This is further confirmed by a broader use of debt securities across rating classes and sectors, notably for lower-rated investment-grade issuers and more cyclical sectors . Nevertheless, this trend seems to be losing traction in the last months. Moreover, smaller companies are confronted with higher difficulties to access financing than larger ones (see ECB, 2014a).

Net issuance of shares (Chart 6) provides information about the actual activity in and recourse to capital markets without the distortion of price movements embedded in the volume series. With the collapse of financial markets in late 2008, NFCs postponed the issuance of new shares until the recovery of 2009. Thereafter, net issuance of shares by NFCs came down to pre-crisis levels. Since late 2013, NFCs are issuing increasing amounts of shares.

Chart 6: Quoted shares issued by Euro Area residents, net flows, year to date, € billion
Notes: MFIs: monetary financial institutions; OFIs: other financial institutions; NFCs: non-financial corporations.
Source: ECB: Securities statistics and own calculations.

The issuance of shares by MFIs followed a different pattern. Throughout the 2000s, it was rather limited; however, since early 2008, banks have been issuing increasing amounts of shares. This was driven by, among other things, the need to absorb incurred losses, the need to provision expected losses or to ease the deleveraging process, but also the pressure stemming from both the regulatory reforms and the markets, including several rounds of stress testing and capital and transparency exercises. The ECB comprehensive assessment may explain the increase in the issuance of shares by banks observed since mid-2013 (see ECB, 2014b). Although the reference date for this exercise was December 2013, data show that banks have been reinforcing their capital positions throughout 2014, upfront of the publication of results to prevent potential negative market effects of potential capital shortfalls detected by the comprehensive assessment. In addition, banks need to comply with the progressive implementation of the capital requirements revised legislation (see European Commission, 2013).

4. Total financing by sector

Previous sections show how the funding mix differs significantly across sector. This section makes a summary of the recourse to financial intermediation and financial markets to finance the activities by each economic sector (Chart 7).

The real economy finances its activities mainly through bank loans. Households use almost exclusively bank loans, but NFCs complement bank loans with a variety of other sources of funding. In terms of evolution, loans to households have stagnated for the last two years. In the case of NFCs, a positive and increasing net issuance of securities compensated the negative net flows of loans. Total net flows of credit turned positive (new financing larger than redemptions) in late 2014 after over a year being negative (redemption exceeding new financing). However, aggregate figures conceal differences across firm size (smaller companies are confronted with higher constraints to access financing than larger ones; see ECB, 2014a) and across countries.

The main two sources of financing for the banking sector are interbank credit and the issuance of bonds. Issuance of shares is marginal. Three main forces are observed from net flows series. First, the financial turmoil eroded the confidence in interbank markets as observed by the collapse in net flows of loans received by MFIs. After remained negative for years, flows of interbank loans have turned positive since late 2014.

Chart 7: Financing sources by sector, net flows, year to date, € billion
Notes: "Total financing" refers to the financing obtained through financial intermediaries and markets. Other sources of funding such as intercompany loans, trade credit, non-quoted shares, etc. are not included.
Source: ECB: Securities statistics and own calculations.

Secondly, due to the high levels of leverage under which the banking system operates, the issuance of equity is lower than both interbank loans and the issuance of bonds by an order of magnitude. Nevertheless, within this scope, banks have issued significant amounts of equity throughout the crisis, either to compensate for losses or to reinforce their capital positions against market or regulatory pressures. The issuance of shares has been particularly important in the last two years.

Finally, the issuance of bonds was relatively less affected in the initial phases of the crisis than interbank lending. This was driven by three main factors: 1) the government support in the form of guarantees on the bonds issued by banks 2) the switch from unsecured to secured lending and the consequent demand of collateral and 3) the possibility of issuing covered bonds to be directly pledged at the central bank to obtain liquidity. However, the need to deleverage constrains banks' balance sheets both on the assets and on the liabilities sides. As a consequence, banks have reduced the rolling over of bonds and large negative net issuances are observed since late 2012.

While loans are also significant, other financial institutions obtain the bulk of their funding through bonds. This is explained, to a large extent, by the central position of OFIs in the process of securitisation. Equity, as in the case of the banking sector, is rather marginal. Net flows of credit to other financial institutions have stagnated since 2010 and became even negative throughout 2014.

Governments are financed mainly through the issuance of bonds. Fiscal needs increased in the first stages of the crisis as reflected in the rally in the net issuance of bonds not only due to the automatic stabilisers but also as a consequence of the support to the financial sector. However, different pressures to consolidate and the substitution of market financing by intergovernmental support in countries with high debt levels (i.e. programme countries) have led to a decrease in the net issuance of bonds to pre-crisis levels.


- European Central Bank (2009). Monthly Bulletin, July 2009. Frankfurt.
- European Central Bank (2013). Banking structures report. November 2013. Frankfurt.
- European Central Bank (2014a). Survey on the access to finance of enterprises in the Euro area. November 2014. Frankfurt.
- European Central Bank (2014b). Aggregate report on the comprehensive assessment. October 2014. Frankfurt.
- European Commission. (2013). Capital Requirements - CRD IV/CRR. Frequently Asked Questions. Memo 13/690, 16 July. Brussels.
- European Commission. (2015). European Financial Stability and Integration Report (EFSIR). April 2015. Brussels.

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