European banks are criticised for holding back economic growth by being unwilling to lend, due in part to capital pressures. However, the real truth is that banks should be given (moderate) credit for being willing to increase risk and grow their books in the face of continued high levels of corporate defaults.
The European Banking Authority in a recent EBA report on Transparency highlighted that banks had been able to increase their common equity tier 1 (CET1) ratio by 1.7% due to increases in capital despite an increase in risk weighted assets.
As the chart shows below, corporate non performing or impaired loans remain a huge challenge for banks and demonstrate why banks often prefer to grow their household lending and maintain significant exposures to sovereign and other financial institutions.
Not only does the level of defaults remain high but banks have probably not fully recognised potential losses in their accounts. The following chart shows that reserves have only been built against 46% of problems. Whereas the ratio of 38% of household loans is probably fine given the high quality and liquidity of mortgage collateral, collateral levels and recoverability is usually weaker in corporate and especially SME lending.
The bad bank set up by the Italians to clean up their banking system is only the first step in the right direction.