RPT-FEATURE-Recovery in Germany runs into credit headwind

* Companies report sharply tighter credit conditions

* Policymakers fume as bankers hoard cash

* Little agreement on what next to boost lending

By Paul Carrel

BERLIN, July 10 (Reuters) - News headlines speak of recovery but for Hannes Hesse, managing director of Germany's VDMA engineering association, financing is still a big problem.

"Conditions are beyond difficult," he says.

The VDMA, whose members include Siemens and Volkswagen, says its incoming business has suffered record declines this year. Now the dearth of credit to tide firms over is a new headache, which frustrated policymakers are blaming on reluctant banks.

A poll in the July 6 edition of business weekly WirtschaftsWoche found some 57 percent of companies surveyed in June were feeling a credit crunch.

In March, only five percent had reported having such difficulty accessing credit.

The frustration stems partly from the fact that late last month the European Central Bank poured 442 billion euros ($615.2 billion) of low-interest one-year funds into money markets -- its biggest ever injection -- that is not trickling down to entrepreneurs.

"It's a euro area-wide problem and therefore this question of a credit crunch is a big issue for the ECB," said Juergen Michels, euro area economist at Citigroup. "It's a big, big headwind for the recovery."

Even though the problem is generating protest from policymakers including European Central Bank President Jean-Claude Trichet and German Finance Minister Peer Steinbrueck, with bankers hoarding cash there is so far little agreement on how best to increase lending flows.

German exporters' association BGA has warned that German firms risk a "massive credit squeeze" by late summer -- a scenario that could throttle any recovery and prolong the deepest post-war recession in Europe's largest economy.

The biggest and smallest firms are suffering most, studies show.

Peter Schaaf, president and CEO of Messer Cutting Systems, a privately held group that makes precision laser-cutting equipment, says his company has financing but his customers are suffering from tight credit which is having a knock-on effect.

"Investments are being postponed because credit lines cannot be put in place," said Schaaf. Asked when customers would get the funds they need, he said: "No one could answer the question."

SLOW RESPONSE

With European business heavily dependent on bank financing, policymakers are reacting.

Trichet and Steinbrueck have both urged commercial banks to pass on to the rest of the economy the liquidity they accessed from the ECB, which Steinbrueck has suggested has gone into foreign exchange, government bonds and shares rather than being passed on as corporate credit.

Trichet too has called upon banks to square up to their responsibilities and support the "real economy".

Lenders face an awkward balancing act: German banks have been hit hard by the global crisis and are carrying billions of euros in problem assets. With their focus now on shoring up capital bases, they are averse to large and long-term loans.

But the economy is showing the first signs of recovery: industry output and orders and exports all rose in May.

"In a way it's quite natural to see this discussion come up now," said Citigroup's Michels. "Before, when everything was going down and companies did not think about future plans, they did not ask for credit."

Surveys in the euro zone show demand for lending is quite weak, but senior bankers say long-term and syndicated loans are proving hard to come by because banks' risk aversion is so high.

The German government has a "bad banks" plan to allow lenders to shift problem assets off their balance sheets, a measure the upper house is expected to approve on Friday.

"It took a long time to come," Volker Treier, chief economist at Germany's chamber of industry and commerce (DIHK) said of the plan. "That's not a criticism -- it just shows the capacity of the political process is limited."

Berlin has also created a 115-billion euro fund to support crisis-hit firms. But Norbert Winkeljohann, a board member PriceWaterhouseCoopers, which audits applications for state loan guarantees, said aid had become harder for small firms to get.

Clemens Fuest, chairman of the Finance Ministry's academic advisory board, said policy has been partly misdirected.

"I would have recommended forcing banks to increase their equity, more along the lines of the British-U.S. model," he said. "That wasn't done in Germany."

The ECB said in its mid-June Financial Stability Report that euro-zone banks will probably need to write down another $283 billion on bad loans and securities over the next 18 months.

WHAT TO DO?

Fuest said Berlin could still push banks to undertake a coordinated share issue, raising funds to boost lending without exposing any individual bank to speculation about the vulnerability of its capital base.

But so far, the government is heading in the other direction: Germany has proposed the Basel II rules on capital requirements be temporarily relaxed, although that plan drew little enthusiasm among EU finance ministers on Tuesday.

Steinbrueck also said the option of using the Bundesbank, Germany's central bank, to lend to firms had to be kept open. But the minister faces political pressure not to tell banks how to do their business.

"We can't have the state taking on banks' business risks, just as it can't force banks to take them either," said Otto Fricke, a member of the Free Democrats (FDP) and chairman of the lower house of parliament's budget committee.

Policymakers may simply need to wait for the "bad bank" measures to take effect, and for lenders to start passing on the funds they have accessed at the ECB.

A record 1,121 banks late last month rushed to take up the ECB's offer of unlimited funds at a fixed rate of 1 percent.

"The take-up from banks was a good sign," DIHK's Treier said. "It's obvious that they won't pump it straight into the real economy. I think it will have a calming effect." (Additional reporting by Tom Kaeckenhoff in Duesseldorf, John O'Donnell in Frankfurt and Matthias Sobolewski in Berlin; Editing by Sara Ledwith)