The Daily Update - ECB / Non-perform loans

Vítor Constâncio, the Vice-President of the ECB, has warned that one of the most pressing issues for the EU banking sector is the nearly EUR1tn of non-performing loans (NPLs) that are still on their balance sheets. Although the ratio of NPL has been declining since its 2013 peak of 8%, it still remains at a stubborn 6%, however there are 6 countries within the EU that have NPL ratios above 10%. Italy alone accounts for 26% of Europe’s NPL’s. Some EUR276bn of Italy’s EUR1.68tn gross loans outstanding are bad.

The problem for countries with high levels of NPL is that there is a strong correlation between high NPL’s and economic performance. Weak GDP and unemployment rates are the two main drivers of NPL’s, which then have a detrimental effect on growth. Countries whose banks have above average levels of NPL see reduced profitability in the banking system, as well as an increase in funding costs and the tying up of capital. All of this has a negative effect on credit supply which then leads to subdued growth.

Vítor Constâncio believes there should be a Europe wide comprehensive strategy that combines a range of suitable tools to deal effectively with the NPL’s problem. One of his ideas is the National asset management companies (AMCs). He thinks this idea looks promising and says ‘National asset management companies (AMCs), if designed correctly, have been successful in relieving banks’ NPL burdens and recovering asset value. A blueprint for national AMCs in the euro area – essentially, a manual for setting up an AMC – would save authorities time and money. In addition to clarifying in detail how AMCs can be made compatible with the EU legal framework, such a blueprint should identify international best practices for key aspects of AMCs such as eligible asset classes, participation requirements, asset valuation, capital and funding structures and governance’.

Apart from AMC’s, he also believes securitisation schemes may also have the potential to kick start a secondary market in NPL’s, however this may mean government intervention to signal the willingness to follow through on reforms to improve asset valuations. To this end NPL trading platforms or clearing houses should be explored to stimulate transaction activity and increase transparency.

Whatever the outcome to these proposals, it is vital that the EU start to look seriously that the NPL problem. The European Commission has recently announced it will put forward suggestions for a coordinated and comprehensive strategy to deal with the problem, including a blueprint for national AMCs. One option the EU does not have is to bury its head in the sand and hope the problem goes away.