Montreal, Canada

Europe's economic recovery is now clearly lagging the United States. Economic data has recently depicted a sputtering advance following the trough in Q1 2009. And although a weaker EUR should help to boost export growth this quarter, the Greek debt crisis has accentuated the difficulties surrounding not only sovereign debt financing but also funding for large and small businesses alike.

In the United States and Europe, small businesses continue to struggle to secure debt-financing. Banks aren't lending to these companies – the backbone of employment growth. Commercial bank loans have declined more than 2% year-over-year in the United States.

Credit intermediation across Europe also remains tepid. Banks are not lending to smaller companies and, despite efforts by the European Central Bank (ECB) to provide funds directly to banks since late 2008, loan growth has stalled.

According to Business Europe, which represents more than 20 million large, mid-sized and small companies, banks in Europe are still reluctant to loan funds to companies because they're worried about future losses on their books; banks also face tougher rules on maintaining capital reserves.

The annualized rate of European loan growth to the private sector turned negative in late 2009, according to Business Europe.

Corporate bond financing, which hit a record in 2009 as companies turned to the market to raise funds instead of securing traditional bank loans, is now saturated by massive weekly government bond auctions. Increasingly, sovereign debt is attracting the lion's share of bond market IPOs since mid-2009, placing more stress on corporate balance sheets as both sources of credit demand chase the same investors.

In order to alleviate debt-financing challenges facing European companies, the ECB might have to resort to direct loans to individual companies – an unorthodox monetary initiative. If banks don't begin to lend then the ECB and The Bank of England will have no choice but to commence direct loan disbursements.

Another alternative is to cut lending rates again. The ECB would be reluctant to reduce near-zero percent interest rates at this point but might have no other choice; perhaps cutting rates to minus 1% would boost lending since the cost of funds would actually impose a liability on cash balances for most banks. The Fed did this in the 1930s.

Increasingly, the bear market rally of 2009 – spectacular by historical standards – is coming to an end as corporate credit or the lack thereof, stifles a sustainable economic recovery. The reality of this recovery, in the West at least, is that the private sector still needs federal assistance and the chain of inter-dependence triggered by the credit crisis starting in August 2007 has not receded across bank lending channels. In many cases, it has become worse.

The big risk to financial markets would be a broad-based tightening cycle by Western central banks – a major policy error at a time when business credit intermediation and a sovereign debt crisis in Europe can't handle tighter money.