EU Bad Bank to Tackle Soured-Loan Pile May Be a Long Way Off

  • EBA says urgent action is needed to reduce nonperforming loans
  • Farkas says proposal avoids risk-sharing opposed by Germany

A European Union bad bank would go a long way toward reducing the 1.2 trillion-euro ($1.3 trillion) mountain of soured loans on lenders’ books, but that relief may be a long time coming, according to the bloc’s bank regulator.

Andrea Enria, chairman of the European Banking Authority, has proposed setting up a bloc-wide asset-management company to take over and manage the sell-off of the loans. The regulator’s executive director, Adam Farkas, said last week that a “realistic aim could be to move about a quarter” of all bad loans off banks’ balance sheets.

Adam Farkas

Photographer: Martin Leissl/Bloomberg

That would be a boon to banks such as Banca Monte dei Paschi di Siena SpA that are drowning in nonperforming loans. Yet creating any new EU entity would be a long, hard slog, Farkas said, beginning with policy debates in Brussels. If a bloc-wide bad bank proves impracticable, a network of national companies would still be a big improvement, he said.

The most ambitious option “would possibly be the most impactful for a number of reasons, but if that is not achievable, the important thing is that a step forward is made,” Farkas said in an interview in London. “What we are arguing is that action is needed. We need to move.”

ECB Targets

The European Central Bank has ramped up efforts to help euro-area banks reduce their stock of doubtful and nonperforming loans, instructing banks to set “realistic and ambitious” targets. The European Commission, the EU’s executive arm, has also taken a crack at easing the burden by overhauling insolvency rules as part of developing the bloc’s capital markets.

Enria’s proposal has gathered heavyweight support from Klaus Regling, managing director of the European Stability Mechanism, and Vitor Constancio, vice president of the ECB. Yet even advocates of the plan acknowledge the difficulties they’ll face in putting it into action.

An EU asset-management company would be welcome, “particularly because it would facilitate raising private funding in the market,” Constancio said on Feb. 3. “A true European AMC faces, however, difficulties in the present environment.”

One hurdle the initiative could face is opposition from Germany and other countries to risk-pooling, an objection that has stalled another pan-EU project, a common deposit insurance system. Farkas said the EBA’s plan gets around this concern.

Risk Sharing

The bad bank would be capitalized sufficiently to issue debt at market rates to fund its operations, Farkas said. Banks would transfer bad loans to the asset-management company, which would have a deadline for selling them on. If the sale price were below the transfer price, or the loans couldn’t be shifted in time, the company could claw back losses from the bank.

“There is no risk-sharing of the losses,” Farkas said. “The only sharing is the capital which is provided, if it’s European money.”

If a bank were unable to absorb the losses, it would become the problem of the relevant national government, not of the EU asset-management company. “This would not necessarily be a for-profit enterprise, but it would not be there to suffer losses,” Farkas said. “The capital would be there in order to allow the AMC to borrow under market terms.”

Germany may take some convincing on this point. Frankfurter Allgemeine Zeitung, one of the country’s leading newspapers, provided a taste of what may come in an op-ed this week, arguing that the proposal would make German depositors “liable for ailing banks in southern Europe against their will.”

A host of issues remain to be discussed on how the fund would operate and even how it could be created under EU law, Farkas said. And that’s all the more reason to get started.

The EBA’s goal is to “induce a more detailed debate on this” and “increase the momentum,” he said.

— With assistance by Silla Brush, and Alexander Weber

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