Euro Banks Barely Cut Bad Debt Levels Under ECB, Linklaters Says

Euro-area banks have only marginally reduced bad loans since the European Central Bank started supervising them last year, and they remain far behind U.S. banks in terms of cleaning their books, according to a study by law firm Linklaters LLP.

The volume of non-performing loans fell only 1.8 percent to 826 billion euros ($914 billion) since the end of 2013, the reference date for the ECB’s comprehensive balance sheet assessment, Linklaters said in a statement. As a share of total assets, NPLs declined to 3.92 percent from 4.13 percent in the period.

“In its first year of operation, the SSM has made good progress in building trust in the European banking system,” says Andreas Steck, a regulatory partner at Linklaters, in a press release. ”The ECB is clearly working hard to deal with NPL resolution and with a working group now in place to tackle these loans, we will see them engaging in a much stronger fashion with national competent authorities and banks to ensure that further action is taken ahead of next year’s stress test.”

The ECB’s supervisory arm sees the persistence of bad loans as one of the main challenges for the banks it’s monitoring, along with weak profitability, its head Daniele Nouy told European Parliament last month. Outsize bad debt levels clog banks’ lending ability and delay the recovery after a financial crisis as they tie up capital and resources that should go towards new lending, economists say.

The bad debt overhang is caused by factors including “general economic conditions, poor banking practices and flawed legal frameworks for debt recovery,” Nouy told Parliament, saying the ECB is therefore working with banks in developing and implementing individual and tailored action plans.

The U.S. banking sector has offloaded a bigger share of bad loans to distressed debt investors, Linklaters’ study found. Demand for non-performing loans has been increasing as Wall Street firms compete to buy the loans at a discount after a real-estate market rebound. U.S. regulators have also provided detailed ”guidance on the treatment of write-offs which have supported NPL reduction,” according to the study. Euro area banks would need to sell 400 billion euros of NPLs to bring the level down to that of U.S. banks, it said.

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