OREANDA-NEWS. The increase in new finance extended to SMEs and corporates - helped by eurozone banks' continued low-margin lending to companies - could drive credit growth in 2016, says Fitch Ratings. The ECB's 1Q16 bank lending survey, published on 19 April, shows that financing conditions for enterprises are improving and rejection rates for loan applications from companies are falling. This trend is set to continue, according to the survey, which is based on replies from 141 banks representing all the euro area countries.

Economic growth in the eurozone could benefit if banks are able to sustain a greater flow of credit to companies. We forecast eurozone GDP growth of just 1.5% in 2016. The increase in corporate lending could also indicate that the ECB's stimulus policies are becoming more effective.

Loan demand from eurozone companies has been growing since 2Q15. Quarterly trends are unsteady but banks expect the positive trend to continue in 2Q16. Heightened competition is the main cause of improving lending conditions, but banks are also signalling a slight increase in risk tolerance and indicating that funding costs and balance-sheet constraints are lifting.

Only Italian banks among those in large eurozone economies cite an improvement in their perception of companies' risks as a material factor in lending on more favourable conditions. This could stimulate growth in Italy's SME sector, where bank lending is the dominant source of funding, but where loan losses have been very high.

Borrowing costs of loans to large companies are reducing more substantially than those to SMEs. In our view, EU banks remain cautious about increasing loans to SMEs, traditionally a higher-risk asset class, due to the tough operating environment. They continue to price risk carefully and lower rates are only available for the best risks, while lending conditions for riskier borrowers have not eased.

This ties in with the European Banking Authority's (EBA) study published on 23 March that found that EU banks' lending growth to SMEs remains well below pre-crisis levels, despite banks being allowed capital reductions against these loans. In contrast, lending volumes to larger corporates and medium-sized companies, where impairments and losses are lower, have already recovered to 2002-2003 levels.

ECB data, which captures lending to non-financial enterprises extended by eurozone banks but does not break out loans specifically to SMEs, confirms that outstanding loan volumes are still well below 2009 levels. But contraction slowed from 3Q14; growth returned in 2015 and has continued into the opening months of 2016.

The EU introduced a capital reduction factor for exposures to SMEs up to EUR1.5m, effective from 2014, to support the flow of credit to SMEs and offset a rise in capital requirements stemming from Basel III capital buffers. This is the "SME supporting factor" (SF).

The EBA found that the SME SF was not effective in boosting lending to this segment and that smaller and younger firms are still particularly credit constrained. The benefit of applying the SME SF to capital ratios varied significantly between countries and banks, but on average across EU banks, the benefit was marginal, leading to a 0.16% increase in common equity Tier 1 capital ratios, to 13.1%.

The ECB's survey indicates that market factors - such as demand and competition - have a more significant impact on lending terms and conditions than regulatory concessions such as the SME SF.