Europe sails into its own credit crunch: James Saft

(James Saft is a Reuters columnist. The opinions expressed are his own)

By James Saft

LONDON (Reuters) - Europe is next in line to feel the impact from tighter credit, a tough situation for an economy heavily dependent on bank financing.

The European Central Bank's April bank lending officer survey showed a continuing sharp tightening in lending standards combined with a weakening in demand for loans.

The survey showed that loans to businesses, consumers and house buyers all became harder to get and more expensive in the second quarter of the year. And future expectations point to further tightening.

Why? Banks are worried about the prospects for the European economy, its housing market, their banking clients and the industries those clients compete in.

Yet even as banks are making their excuses to clients and declining to lend, those same clients are backing out of the door, smiling tightly and politely declining to apply for loans in the first place. Demand for loans in the euro area is deteriorating at the most rapid pace in the survey's five-year history, according to the ECB, due to less interest in fixed investment or in mergers and acquisitions.

That could lead you to conclude that Europe is experiencing a normal slowdown but not a credit crunch.

However, while the euro zone has thus far been spared the worst of the impact of the global credit difficulties, there is reason to believe that is more a matter of timing than immunity.

"If the economy is slowing down and you get a supply-driven credit squeeze on top, then you might face a more significant and more prolonged downturn in economic growth," said Marco Annunziata, head of global economics at Unicredit in London. "In Europe this is a significant risk."

Bank borrowing by euro area non-financial corporations grew at an annual rate of 15 percent in the year to March 2008, a healthy clip by anyone's standards. But, to put it bluntly, much of that lending has been involuntary.

With the capital markets largely shut, especially for riskier borrowers, many European companies have doubtless drawn down on their existing lines of credit. Those loans, many of which have 364-day maturities, were entered into before the credit storm, and when it comes to refinance, those corporations will find less money available, at a higher costs and with stricter standards as to who is fit to borrow.

Remember, too, that for the banks this forced growth in their outstanding loan book has been painful. Many of the margins charged on these old loans are now uneconomic for banks, and they are under pressure to rebuild their balance sheets rather than lend more.

According to Julian Callow, economist at Barclays Capital, the changes in loan officer sentiment in the equivalent and much older U.S. survey tend to lead actual changes in lending by about a year and a half.

So expect Europe's lenders to cut back on lending as soon as they get the chance.

AN ECONOMY DEPENDENT ON ITS BANKS