European banks harbouring €990 billion in bad loans

Some €990 billion in bad loans in the European banking system represent 6.7 per cent of the size of the EU economy, according to a report and action plan considered by EU finance ministers on Tuesday.

That compares with non-performing loans (NPL) ratios in the US and Japan of 1.7 per cent and 1.6 per cent of gross domestic product, respectively.

In 10 EU states, however, Ireland included, the ratios remain above 10 per cent, while declining in most.

In Ireland that decline from the third quarter of 2013 to December 2016 was some 42 per cent, down to 13.6 per cent of GDP, as banks have restructured problem loans at pace under the direction of the Central Bank.

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In Greece and Cyprus the ratios remained at 46 and 45 per cent respectively at the end of 2016, with the former still rising.

The Ecofin meeting in Brussels opened preliminary consideration on the action plan prepared by a European Council sub-committee that focuses on four main areas: enhanced supervisory practices, structural impediments like reform of insolvency and debt recovery practices; the expansion of underdeveloped secondary markets for debt, including the possibility of establishing new “bad banks”, or asset management companies, and bank restructuring.

European authorities will also prepare by the end of next year enhanced disclosure requirements on bad loans.

Action plan

The report and action plan come against the backdrop of the European Central Bank, which took control of euro area bank supervision in 2014, putting increased pressure on banks this year to come up with plans to deal with their remaining bad loans.

Aside from continuing to restructure and ease terms of unsustainable debt, Ireland’s banks are known to be considering assets sales and the setting up of off-balance sheet structures ease the burden of NPLs on their earnings.

EU officials say there is “no silver bullet” and that it is important to “take the menu as a whole”.

The report says that the NPL ratio of exposure for SMEs (16.7 per cent) is more than twice the level for large companies (7.5 per cent) and treble that for households (4.7 per cent). Probability for default is also higher for SMEs. The same is true of smaller banks’ exposure.

The report finds a close correlation between economic growth and declining NPL ratios which can also be affected negatively by exchange rate fluctuations and falls in stock markets.

‘Negative effects’

The action bluntly warns that “the negative effects of current high NPL ratios in a substantial number of member states can pose risks of cross-border spill-overs in terms of the overall economy and financial system of the EU and alter market perceptions of the European banking sector.”

“The recovery under way in Europe should contribute to the reduction of the stock of NPLs and NPL ratios by improving the service capacity of borrowers . . . However , given the slow pace of the recovery and inflation outlook weighing on the private sector’s ability to service the loans , this process is likely to be lagged and protracted,” the report warns. Resolute efforts are needed to address both NPLs and private sector debt.

The report outlines approvingly the special measures taken in Ireland, from creating an asset management company, Nama, to new supervisory and legislative measures.

“One of the main messages from the Irish experience is that there is no single measure which taken in isolation would reduce the NPLs and that it takes time for the positive actions to give sustainable results.”

The plan which has taken eight months to draft reflects wide differences both in experience and outlook among member-states.