This article is part of a series of analyses on the challenges facing banking this decade, by Dr Andrei Radulescu, Head of Macroeconomic Research at Banca Transilvania, and also published on the BT Blog.

One of the challenges facing the global and European banking sectors today is the build-up of excess liquidity, which represents an opportunity cost for banks, especially in a low interest rate environment. This trend is driven by several factors:

1. the high household saving rate (at record highs right after the pandemic broke out, as shown in the next chart), supported by buoyant housing market conditions (rising real estate prices and the resulting wealth effect);
2. the upward trend in corporate earnings globally, against the backdrop of growth and development in the real economy, the adoption of technological progress and consolidation (mergers and acquisitions);
3. tighter regulation (implementation of Basel III), which has affected lending activity (unprecedented caution to avoid another adjustment episode like the one triggered by the Great Recession);
4. favourable financial market conditions and a faster pace of financial innovation (including the growth of shadow banking), which have encouraged companies to turn to non-bank sources of funding;

As a result, the household saving rate has increased significantly both in the United States (the world’s largest economy, accounting for 25% of global GDP) and in Europe, to record levels after the coronavirus pandemic hit, and has remained elevated after the lifting of the restrictions introduced in response to the health crisis.

Household saving rate

Source: Bloomberg

At the same time, corporate profitability improved significantly over the post‑crisis cycle (until the pandemic struck), supported by growth in the real economy (Romania has been a champion of growth, development and convergence over recent decades), as well as by the high ratio of gross operating surplus to gross value added (in Romania, well above the European Union average).

In Romania, the ratio of gross operating surplus to gross value added averaged 55.7% over 2009–2019, higher than in Poland (49.1%), Germany (40%), the Eurozone (39.8%), the European Union (40.4%) and the United States (32.9%).

Gross operating surplus/gross value added ratio

Source: Eurostat

By contrast, net lending by non‑financial corporations — as a share of gross value added — was low during the post‑crisis cycle, and fell sharply in Romania in 2019.

Net lending/gross value added ratio for non-financial corporations

Source: Eurostat

The loan‑to‑deposit ratio in the banking sector has fallen significantly over recent quarters (particularly after the pandemic hit).

In the United States (with nominal GDP of USD 20.9 trillion in 2020), the loan‑to‑deposit ratio for all commercial banks stands at around 90%, an all‑time low for the Federal Reserve series, which go back to the 1970s.

Loan‑to‑deposit ratio — all US commercial banks

Source: BT based on Federal Reserve (Fed) data

In the Eurozone, the loan‑to‑deposit ratio decreased by 7.1 percentage points between end‑2019 and end‑June 2020, to 95%, a record low.

Last but not least, in Romania, the loan‑to‑deposit ratio has been on a steep downward trend in recent years, to 69% at the end of the first half of 2021 (down 4.2 percentage points compared with December 2019), as shown in the chart below.

Loan‑to‑deposit ratio — Eurozone banking system

Source: European Central Bank, National Bank of Romania

To sum up, the excess liquidity in the system enables banks in Romania to finance the real economy, but a number of factors outside the banking sector are responsible for the low level of lending:

• high levels of trade credit (a traditional source of funding for companies in Romania);
• the large number of non‑bankable companies (according to a National Bank of Romania analysis published at end‑2019, over 244,000 firms, 35.4% of the total, had equity below the regulatory minimum, and 97% of these had negative equity);
• multinationals’ preference for funding from their parent companies or from banks outside Romania;
• the underdeveloped equity market and corporate bond market, although there has been progress in recent years;
• the increasing role of EU funds in the post‑crisis cycle, a trend that will continue in the post‑pandemic cycle.

Read also about A paradigm shift in monetary policy, by Andrei Radulescu, BT.

The next articles on the challenges for banking this decade will be about:

• Banking system asset structure – developments in the Eurozone
• Structural developments in Romania’s banking sector after the Global Financial Crisis
• Outlook for the banking sector