Europe’s bad loan problem could last a generation

The instability and market turmoil following the Brexit vote has once again turned the spotlight on the weakness of eurozone banks. The total stock of non-performing loans (NPLs) in the euro area is €900 billion or about 9% of gross domestic product. At current rates of reduction it will take Italy more than 20 years to reduce its NPLs to the pre-crisis levels of 2008, Ireland needs between 10 and 15 years and Belgium needs between five and 10 years. 

Economic growth is being held back until a solution is found but, as with most things EU, policy making has ground to a halt and there is a lack of will to complete the badly needed banking union. 

In this year’s Top 1000 World Banks ranking compiled by The Banker, three eurozone countries – Greece, Cyprus and Portugal – all reported banking sector losses and are among the ten least profitable countries in the world. 

What is to be done? Morgan Stanley’s vice-chairman for sovereigns and official institutions, Reza Moghadam, has proposed a European Asset Management Company funded by all eurozone governments to buy NPLs from European Central Bank-supervised banks. The losses resulting from the transfer would be borne by shareholders and bondholders but not depositors. 

But doing this in Italy would still be challenging as many bank bonds are held by retail investors. The Italian government wants to provide state support, yet that would break EU rules requiring investors to be bailed in first. Hence we have a stalemate.

In its latest report on the euro area, the IMF says that the Single Supervisory Mechanism should “set aggressive time-bound NPL disposal targets”, lengthy recovery procedures should be shortened and distressed debt markets need to be developed. 

“In systemic cases where state intervention may be warranted, EU state aid rules should be exercised flexibly as permitted, recognising that the correct determination of ‘market prices’ is difficult without a functioning market,” says the International Monetary Fund (IMF). 

The problem is that – as with the Greek bail-outs – the IMF can come up with sensible, detached solutions to problems but in the EU context these measures invariably run into a wall of national self interest. 

Countries such as Germany and the Netherlands are resisting any sharing of risk across borders as they do not want to foot the bill. A common deposit guarantee scheme, essential for a banking union, is being resisted for the same reason. 

Following the Brexit vote there have been calls across the EU for reforms to be addressed to ensure the survival of the union. But such initiatives invariably run into national paralysis. Sadly it may take a worse crisis to really move the dial forward. 

Brian Caplen is the editor of The Banker.