ECB Ramps Up Effort to Shrink Banks’ Mountain of Bad Loans

  • ECB is late to the game, guidelines aren’t a fix, MEP says
  • Guidance is non-binding, collateral valued at market prices

The European Central Bank ramped up efforts to tackle the mountain of soured loans that weighs on many euro-area banks, seeking to repair damage caused by years of lax supervision and feeble economic growth.

The ECB’s draft guidelines aim to help euro-area banks get out from under 1.1 trillion euros ($1.2 trillion) of doubtful and non-performing loans. The proposals issued on Monday address the “main aspects regarding strategy, governance and operations” needed for banks to reduce their stocks of bad loans, and set out best practices that will “constitute the ECB’s supervisory expectations going forward,” the central bank said in a statement.

Daniele Nouy, head of the ECB’s supervisory arm, has made tackling non-performing loans a priority since the Frankfurt-based central bank began overseeing euro-area banks in 2014. The problem, which is particularly acute in Italy, has been exacerbated by factors including the anemic economy, “poor banking practices, flawed legal frameworks for debt recovery and a lack of capacity in the judiciary system,” Nouy said in June.

Markus Ferber, a German lawmaker in the European Parliament, said the ECB is “alarmingly late to consider the problem,” and it’s “clear that new ECB guidelines alone will not do the trick unless countries such as Italy commit to painful restructuring.”

‘Big Drag’

Non-performing exposures are a “big drag on lending and economic activity,” and the huge volume of soured loans on the books of euro-zone banks shows that supervisors like the ECB “have failed to do their job for years,” Ferber said.

Nouy last year turned to Ireland’s head of banking regulation, Sharon Donnery, to lead the charge on soured loans, citing that country’s “good work” on the issue. Donnery heads a working group on resolving loans in partial or full default. Irish banks have trimmed their non-performing loans from 53 billion euros in June 2014 to 31 billion euros in March 2016.

“Asset quality remains a serious challenge for many European banks,” Donnery told journalists on Monday. “High levels of non-performing loans can constrain both credit growth and economic activity. This is because NPLs tie up bank capital, restricting banks’ ability to undertake new lending.”

‘Extend and Pretend’

The ECB is keen to put an end to banks’ procrastination in dealing with their bad loans by waiting for asset prices to recover or by rolling over loans, a process known as “extend and pretend.” The central bank said it “expects banks with high levels of NPLs to implement targets for reducing those NPLs that are both realistic and ambitious.”

For Italian banks loaded with distressed exposures, the ECB’s guidance may bite by forcing them to “speed up the schedule regarding their NPL recoveries/disposals, leading to a ‘funnel’ that could trigger price compression and hence further provisions on loan losses,” said Fabrizio Bernardi, an analyst at Fidentiis Equities.

While the guidelines are not binding, failure to observe them will have to be explained and may be penalized. This will allow banks to set their own targets, taking into account criteria set out in the guidelines. The resulting plans will be agreed upon with supervisors, Donnery said.  Market prices should be used in valuing collateral.

“The ‘wait-and-see’ approach, too often observed in the past, has not solved the issue,” the ECB said.

The consultation period for public comment on the ECB’s proposals runs until Nov. 15.

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