Energy price shock curbed bank lending, ECB study finds

The surge in energy prices following Russia’s invasion of Ukraine significantly reduced bank lending to energy-intensive companies, according to an ECB working paper, with the study concluding that firms most exposed to higher energy costs borrowed less while banks also imposed stricter lending conditions. The paper, authored by Niels Framroze Moller and Johannes Poeschl, examines how the unprecedented energy price shock affected bank credit to businesses, using Denmark as a case study with implications for the wider euro area and central banks. Although the research focuses on Danish manufacturing firms, the authors said the findings are relevant for the euro area because they illustrate how a sudden rise in production costs can influence credit markets, alter the transmission of monetary policy and create risks for financial stability. The study found that bank lending to highly energy-intensive firms persistently weakened after Russia’s invasion of Ukraine, while those companies also faced higher interest rates on new loans, shorter loan maturities and tighter collateral requirements. At the same time, the researchers found that safer companies generally reduced their use of existing credit lines while continuing to obtain new loans at broadly unchanged interest rates, whereas riskier firms faced higher borrowing costs. According to the paper, the energy shock acted as an additional tightening force for firms with the greatest exposure to energy costs, even though total lending to the manufacturing sector as a whole continued to increase. The authors explained that their research helps address a gap in existing literature, which has largely focused on predictable energy price changes linked to environmental regulation rather than sudden, unexpected shocks such as those triggered by geopolitical events. They argued that understanding these effects is important for assessing both monetary policy transmission and financial stability across the euro area. The research combines three confidential firm-level datasets covering several years before and after Russia’s invasion of Ukraine. These include a detailed survey of energy use by Danish manufacturing plants with more than 20 employees, the Danish credit register containing quarterly information on all bank loans and credit lines, and company balance sheet and income statement data. Using these sources, the researchers calculated each firm’s energy intensity, defined as the share of energy costs in overall production costs, before tracking borrowing behaviour and lending conditions over time. To isolate the impact of higher energy prices from other events occurring after the invasion, the study compared companies with similar characteristics operating in the same industries and borrowing from the same banks, but with different levels of exposure to energy costs. The authors explained that the invasion also generated numerous other shocks, including increased geopolitical risk, lower consumer confidence and supply chain disruptions. To minimise the influence of these factors, the researchers used a difference-in-differences methodology combined with detailed industry and bank controls, together with additional robustness checks covering company size, age and leverage. This allowed them to interpret differences in lending between highly energy-intensive and less energy-intensive firms as the causal effect of the energy price shock. The paper found that credit growth among highly energy-intensive firms was 8.75 percentage points lower than that of less energy-intensive companies during the second quarter of 2022, the first full quarter after the invasion. That gap remained in place for several quarters before closing around the third quarter of 2023. The researchers estimated that overall lending to Denmark’s manufacturing sector would have been around 5.5 per cent higher if energy-intensive firms had borrowed at the same pace as less energy-intensive businesses. They said the scale of the decline was broadly comparable to the effect on lending associated with a half percentage point increase in short-term interest rates, as reported in previous banking research. The analysis also sheds light on why borrowing fell. Rather than banks immediately withdrawing funding, the largest contribution came from companies making less use of existing credit lines. Approximately three-quarters of the decline in lending was linked to reduced utilisation of credit lines, while most of the remainder reflected lower use of credit cards. The researchers said unreported findings indicate that the reduction primarily resulted from companies drawing less on existing facilities rather than banks reducing available credit limits. This suggests that weaker credit demand, rather than an outright restriction in credit supply, accounted for most of the decline. The authors argued that many energy-intensive firms probably delayed or cancelled investment plans because of heightened uncertainty and weaker profit expectations instead of relying more heavily on bank borrowing to finance higher energy costs. However, the study also found evidence that banks became more cautious when issuing new loans. Energy-intensive companies obtaining fresh financing paid interest rates roughly 1 percentage point higher than comparable firms with lower energy exposure. New loans also tended to have shorter maturities and somewhat stricter collateral requirements. After controlling for differences in borrower risk and loan characteristics, the researchers found that interest rate spreads still increased for energy-intensive firms, suggesting banks began pricing energy-related risks separately from traditional credit risks. The paper therefore concludes that both lower demand for borrowing and reduced bank risk appetite contributed to weaker lending. The research identifies several possible transmission channels. On the supply side, the authors point to a credit risk channel and a risk-taking channel, while on the demand side they identify working capital, investment and precautionary savings channels. Each of these mechanisms produces different effects on borrowing volumes and loan conditions. The study also found significant differences between companies. The decline in borrowing was strongest among firms considered relatively safe before the energy shock and those holding larger cash balances, both groups generally regarded as being less financially constrained. In contrast, higher interest rate spreads on new loans were observed mainly among riskier borrowers, suggesting banks demanded a larger risk premium from those companies. To ensure the findings were not driven by other company characteristics, the authors carried out a series of robustness tests. These included examining pre-shock lending trends, using an alternative measure of energy intensity based on differences within industries, exploiting differences in the timing of energy contract renewals during 2022, and controlling for interactions involving company size, age and leverage. Across all of these exercises, the main conclusions remained unchanged. The paper concluded that Denmark’s experience demonstrates how large energy price shocks can reshape the allocation of bank credit, even when overall lending across the economy remains relatively stable. For the ECB and other central banks, the authors said such shocks can create financing pressures for specific sectors that depend heavily on both energy and bank lending. They added that monitoring firms’ exposure to energy costs, alongside banks’ sectoral lending concentrations, could improve assessments of how future energy shocks would affect the euro area economy and support both monetary policy analysis and financial stability monitoring.