Executive summary

Eight years after the start of Europe’s financial crisis, the legacy of non-performing loans and excessive private debt remains a key obstacle to the recovery of bank credit and investment.

We argue that efforts to reduce and remove NPLs from the balance sheets of creditors must simultaneously remove excess debt from the balance sheets of debtors. This is the only way to ensure that bank balance sheets are restored to health sustainably, and that both supply and demand for new credit revive.

A comprehensive strategy to tackle legacy assets should include national debt reduction strategies that guide bank NPL reduction targets, strengthen frameworks for restructuring and insolvency, simplify the engagement of specialist investors within the capital markets union and, crucially, create a blueprint for national asset management companies.

There is a need to strengthen policies in four key areas:

First and foremost, recapitalise banks to enable them to provision distressed loans adequately, and then actively participate in restructuring or writing off unviable loans.

Second, encourage further legal reform that is also supported by adequate restructuring capacity within the banks and elsewhere in the private sector, including by attracting specialist investors.

Third, create a tax regime and flexibility in revenue management that encourages the public sector to participate in debt restructuring.

Finally, establish asset management companies that can overcome the various market failures in terms of removing distressed assets from banks’ balance sheets.

NPLs are concentrated in particular countries but are a problem for the entire euro-area banking system given the many financial and real spillovers across the currency area. There is a clear need for national reforms that create a more supportive environment for debt restructuring and deleveraging. But many policies will also need to be coordinated within the euro area, and possibly within the single EU capital market.