Blog Post

Bruegel conference discusses strategies to tackle Europe’s NPL crisis

Bad loans and private sector debt distress are widely acknowledged to hold back investment and growth in Europe. It was good, then, to hear ECB Vice-President Vítor Constâncio call for a comprehensive strategy to address the non-performing loans problem at an event hosted by Bruegel last week.

By: and Date: February 7, 2017 Topic: Finance & Financial Regulation

Europe is facing a non-performing loan (NPL) crisis. Bringing together over 100 senior experts from the EU institutions, national authorities and key market participants, a recent Bruegel conference discussed current options and novel approaches.

The event was held mainly under the Chatham House rule. Thus what follows is a brief, personal and necessarily partial summary. But we nonetheless hope it provides a sense of what has once again become a very lively – and increasingly urgent – policy debate.

There was near universal recognition at the conference that Europe has been far too slow in addressing non-performing loans. The risks associated with continued inaction were seen as significant: if the bad loan overhang is unresolved, a Japanese-style debt deflation looms.

Bank supervision will require complementary reforms

The bad loan overhang is now rightly a priority for the ECB’s single supervisory mechanism (SSM). Our discussion showed broad support for the ECB’s new guidelines on banks’ management of NPL portfolios. In her remarks Sharon Donnery, Deputy Governor of the Central Bank of Ireland, and chair of the ECB’s high level group on NPLs, provided some more detail on implementation. This will require “strong and clear support from Member States to tackle legal and related issues”.

But NPLs were also described as a key factor behind the broader problem of banks’ entrenched low profitability.  The diminished earnings outlook of course compromises the capacity to raise much needed fresh capital – in turn undermining banks’ efforts in bad loan workouts.

In addition, banks will need to take a deeper look into their borrowers’ viability. The EU’s new accounting standard (IFRS 9) will force them to adopt a more forward-looking credit quality assessment. In the most affected countries supervisors should be part of the broader debt restructuring effort.

Engaging investors

Participants in our conference also felt that specialist investors must complement the workout of distressed loans within banks. However, secondary markets are generally poorly developed and investors’ positions uncertain, which results in wide gaps between valuations. Where information on loans is poor, or poorly communicated, the market will not clear, and the quality of assets that are transacted deteriorates.

A key topic of discussion was therefore which institutions and common norms could facilitate the entry of investors. In the first instance, it will be the responsibility of banks to provide accurate information to bidders. Some significant euro area banks have already implemented the required changes to internal capacity and management. Crucially, the transfer of distressed assets out of bank balance sheets could underpin the much-needed capital raising effort by European banks. A convincing and well-resourced strategy could reassure investors, as well as credit markets.

Servicing companies could share their skills more widely. As regulation still diverges widely national rules could be simplified, and the EU’s capital markets union could set a common framework.

The conference discussion therefore returned to NPL clearing houses, which were proposed by EU Commission officials recently. In some markets clearing houses might be a useful tool in reassuring potential investors; for larger or more heterogeneous exposures originating banks will need to make better efforts in bridging information gaps. In any case, this would be no substitute for asset management companies which could act as a ‘market maker’ in the secondary market.

NPLs represent a shared EU problem – a comprehensive strategy is required

In his published remarks ECB Vice-President Vítor Constâncio called for comprehensive strategies to address the NPL problem, including through a harmonised approach at European level. All options for NPL resolution – ranging from workout within the bank to a sale to external investors – will also require national structural reforms, importantly through a strengthening of insolvency procedures and of the court systems.

Asset management companies (AMCs, often unhelpfully known as bad banks) had a catalytic effect in overcoming market failures in several European debt crises. But typically, these institutions require some form of government support.

Existing EU law already offers scope to establish such AMCs at national level. The Vice-President also suggested an EU-wide AMC could be sensible. Yet, our discussion also highlighted some concerns how such an institution would bridge very different legal regimes, and that some countries have already made more progress than others in addressing their NPL overhang. In the immediate future, a blueprint for national AMCs may be more realistic. This should define the permissible flexibility under the existing EU framework, and encourage countries to establish AMCs.

The Vice-President’s comments echoed the proposal made by Andrea Enria of the European Banking Authority (EBA) earlier in the week. Conference participants generally agreed with the premise that Europe’s NPL burden unsettles potential investors, leading them to stigmatise the European banking system. Common solutions would send a strong signal, and could offer efficiencies in funding and governance in new institutions. Given the ongoing value destruction within distressed debtors speed is of the essence.

A broader use of AMCs – whether at national or European level – could be accommodated within the existing rules on bank resolution and state aid, and should not give rise to a mutualisation of legacy assets.

Several participants nevertheless cautioned that new institutional solutions must not undermine the credibility of the existing framework for bank resolution, nor should they distract from rigorous supervision by the SSM. A faster pace of bank exits, and consolidation was in any case needed.

Designing such a comprehensive strategy should now become an objective for EU ministers. Solutions that bridge the various market failures and regulatory uncertainty are clearly needed, even though an EU-wide strategy should not constrain individual national solutions.

National ownership is critical

The conference discussion of experiences and agendas in four euro area countries underlined once again that there needs to be strong political ownership for this agenda within national authorities. SMEs and larger enterprises present challenges in restructuring, and fresh capital and management is often required. Some of the euro area crisis countries that have undergone comprehensive bank restructuring have progressed to a recovery in lending and investment. Defining a clear EU institutional framework that addresses market failures could move banking systems more broadly to a stronger equilibrium.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article More on this topic

Blog Post

Providing funding in resolution: Unfinished business even after Eurogroup agreement on EMU reform

The recent Eurogroup agreement on euro-area reform foresees a greater role for the European Stability Mechanism (ESM) as a backstop to the banking union. This is a welcome step forward but important issues remain. We assess the agreement on how to fund banks after resolution and the best way to organise the fiscal role in liquidity provisioning to banks. We argue that the bank resolution framework will remain incomplete and its gaps could result in important financial instabilities.

By: Maria Demertzis and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: December 7, 2018
Read about event

Past Event

Past Event

European Banking Supervision: the past five years and prospects for the future

This event will look back at the first five years of the Single Supervisory Mechanism.

Speakers: Danièle Nouy and Guntram B. Wolff Topic: European Macroeconomics & Governance, Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: November 20, 2018
Read article More on this topic More by this author

Podcast

Podcast

Deep Focus: How to improve anti-money laundering efforts in Europe

In this episode, Bruegel senior fellow Nicolas Véron joins Sean Gibson to discuss the recent Policy Contribution on how to better the European Union anti-money laundering (AML) regime, a paper he has co-written with Joshua Kirschenbaum.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: October 30, 2018
Read article Download PDF More on this topic

Policy Contribution

A better European Union architecture to fight money laundering

A series of banking scandals in multiple EU countries has underlined the shortcomings of Europe's anti-money laundering regime. The impact of these shortcomings has been further underlined by changing geopolitics and by the new reality of European banking union. The imperative of establishing sound supervisory incentives to fight illicit finance effectively demands a stronger EU-level role in anti-money laundering supervision. The authors here detail their plan for a new European unitary architecture, centred on a new European anti-money laundering authority that would work on the basis of deep relationships with national authorities.

By: Joshua Kirschenbaum and Nicolas Véron Topic: European Macroeconomics & Governance Date: October 25, 2018
Read article More on this topic More by this author

Opinion

Global markets’ tepid reaction to China’s new opening

China’s accession to the World Trade Organisation in 2001 was greeted with great fanfare. But near silence has greeted the recent removal by the China Banking and Insurance Regulatory Commission of caps on foreign ownership of Chinese financial institutions. For Beijing, the apparent lack of interest might be an issue of too little, too late.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: October 11, 2018
Read article Download PDF

Policy Contribution

European Parliament

Excess liquidity and bank lending risks in the euro area

In this Policy Contribution prepared for the European Parliament’s Committee on Economic and Monetary Affairs (ECON) as an input to the Monetary Dialogue, the authors clarify what excess liquidity is and argue that it is not a good indicator of whether banks’ have more incentives in risk-taking and look at indicators that might signal that bank lending in the euro area creates undue risks.

By: Zsolt Darvas and David Pichler Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: September 26, 2018
Read article More on this topic More by this author

Blog Post

Lehman Brothers: 10 Years After

Ten years after the bankruptcy that shook the world, we review economists’ take on the lessons learned from the global financial crisis.

By: Silvia Merler Topic: Finance & Financial Regulation Date: September 10, 2018
Read article More on this topic More by this author

Blog Post

Criteria for entry into the ERMII and the banking union: the precedent from Bulgaria

In its bid to join the single currency Bulgaria has made commitments on financial supervision but also wider structural reform which set a precedent for future applicants for participation in the exchange rate mechanism ERMII. Most conditions, though not all, are justified by the additional demands of the banking union. But the envisaged timeline seems ambitious, and verification will not be straightforward.

By: Alexander Lehmann Topic: European Macroeconomics & Governance Date: August 29, 2018
Read article

Blog Post

Germany’s savings banks: uniquely intertwined with local politics

German savings banks, known as Sparkassen, form an important feature of the country's banking assets. Unlike in other European countries, German Sparkassen also hold direct links with local political communities. This post focuses on the Sparkassen's structural links and relationships with elected politicians. Three findings which do not appear to have been specifically documented previously stand out.

By: Jonas Markgraf and Nicolas Véron Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: July 18, 2018
Read article More on this topic

Blog Post

European bank mergers: domestic or cross-border?

As the European economy recovers from the global financial crisis, bank mergers are back on the agenda. While cross-border mergers have been predicted before, most European bank mergers have been domestic until now. What are the odds of cross-border mergers in the upcoming bank-consolidation wave?

By: Patty Duijm and Dirk Schoenmaker Topic: Finance & Financial Regulation Date: June 21, 2018
Read about event

Past Event

Past Event

Where is China’s financial system heading? Implications for Europe

How ready is China for the transformation of its financial system and how will this effect Europe?

Speakers: Elena Flores, Alicia García-Herrero, Gene Ma, Hu Yuwei and Guntram B. Wolff Topic: Finance & Financial Regulation, Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: May 25, 2018
Read article More on this topic More by this author

Blog Post

Latvia’s money laundering scandal

Latvia’s third largest bank ABLV sought emergency liquidity from the ECB and eventually voted to start a process of voluntary liquidation, after being accused by US authorities of large-scale money laundering and having failed to produce a survival plan. What does it mean for the ECB?

By: Silvia Merler Topic: Finance & Financial Regulation Date: April 9, 2018
Load more posts