Business bank lending sentiments deteriorate to lowest level in a decade

Luxembourg banks anticipate a significant decrease in loan demands from the business economy in Q1 2023, marking the lowest level since 2013, when data on this metric became available.

Forward-looking business loans can serve as a reliable indicator of the economic outlook. As companies flourish, they often seek financing through business loans to support expansion and other operational activities. Therefore, a rise in business loan applications can reflect a positive outlook for businesses, signalling an eagerness to pursue growth opportunities. Conversely, a drop in demand for business loans may indicate that companies are hesitant to invest and expand, possibly due to external factors or economic uncertainty.

Looking at past trends, following the global financial crisis in 2008 and 2009, nearly half of the Luxembourg banks surveyed (49%) expected a decline in long-term loans, which usually span over a year, in the next three months in Q1 2009, while only one in seven (14%) banks had a negative outlook, indicating that short-term sentiments improved much faster. To stimulate economic recovery, the European Central Bank decreased its main refinancing rate by 1.25 percentage points (pps) between November 2008 and January 2009, from 3.25% to 2.00%.

Again in 2011 and 2012, Europe faced a sovereign debt crisis that threatened the stability of the eurozone. In response, the ECB increased its main refinancing rate by 0.5pps, from 1.0% to 1.5% between April and July 2011, which is the rate at which commercial banks can borrow money from the central bank. This resulted in an increase in the interest rates charged on loans by commercial banks to businesses, making it more expensive for businesses to borrow money.

As a result, the demand for both short-term and long-term business loans dropped sharply during Q3 and Q4 2011. However, by December 2011, the ECB lowered its main refinancing rate back to 1.0%, which led to higher demand for loans and an exceptional recovery in business loans outlook in Q1 2022. Together these indicate how business loans are sensitive to ECB interest rate hikes.

In contrast, between November 2022 and March 2023, the ECB increased its main refinancing rate by 1.5pps, from 2.0% to 3.5%, which was an exceptional increase, and the decrease in business loans followed. In Q1 2023, four out of five Luxembourg banks (80%) anticipated a decline in three-month forward-looking demand for long-term business loans, while three out of five banks (60%) expected a decrease in business loans.

This suggests that the commercial banks are anticipating a much wider slowdown in business activities.

Indeed, the outstanding amount of total loans granted by euro area banks to business enterprises in Luxembourg dropped in Q4 2022, for the first time since Q4 2020, confirming the slowdown in business loans.

The ECB declined to comment on how many Luxembourg banks participated in the survey, citing confidentiality reasons.