Central bank and EU authorities have been in talks to set up a ‘bad bank’ to absorb expected surge in NPLs from Covid-19.
The European Central Bank (ECB) is reportedly pushing for a ‘bad bank’ to mop up remaining non-performing loans (NPLs) dating from the 2007–2009 global financial crisis amid concerns about a second wave of NPLs sweeping through the eurozone.
The central bank’s concerns have been accentuated by renewed population shutdowns across Europe in response to the rapid pick-up in Covid-19 infections. In addition, there is evidence from an ECB third-quarter lending survey that eurozone banks are reducing credit to the economy and becoming more cautious.
The European Commission is however resistant to the idea of a ‘bad bank’ as it is reluctant to waive EU rules requiring state aid for banks to be provided only after a resolution process imposes losses on investors, according to report in the Financial Times.
A public asset management company, if smartly structured... would contribute to market confidence in the sector
‘Bad banks’ are widely seen by economists as an effective means of cleaning up struggling banks and enabling them to resume normal lending relatively quickly.
Enthusiasts hope to make the concept acceptable under state aid rules by stating that NPLs must be sold to investors after a fixed time period and give them the power to recoup losses from the lenders.
Prior to the bank recovery and resolution directive coming into force, EU countries such as Spain, Germany and Ireland used ‘bad banks’ to rebuild severely impacted banks.
Loan loss estimates
Andrea Enria, head of the ECB’s supervisory board, recently said banks must publish credible loan loss estimates as part of their quarterly updates.
Mr Enria threatened that unless the ECB was satisfied with these estimates, the ban on dividend payments and share buy-backs could be extended beyond the end of this year.
He warned that eurozone banks could face up to €1.4tn worth of NPLs as a result of the pandemic.
Scope Ratings said in a note to make a ‘bad bank’ or pan-EU public asset management company more palatable to national policy makers, it should be limited to the eurozone. Also, it should only accept pandemic-related NPLs from bank core markets and exclude legacy NPLs from the last crisis, which should be dealt with through the existing mechanisms.
“I believe [a public asset management company] if smartly structured and reassuringly transparent, would contribute more to market confidence in the sector than the elusive third pillar of [the European Deposit Insurance Scheme],” wrote Sam Theodore, head of credit at Scope Ratings.
This article first appeared in The Banker's sister publication Global Risk Regulator.
