Photographer: Jasper Juinen/Bloomberg

EU Eyes Taxpayer Cash to Help Ailing Banks Offload Bad Loans

  • EBA’s Enria says urgent action is needed to tackle asset issue
  • EU officials say use of state aid is conceivable in such cases

European Union banks may be allowed to tap public funds to offset losses when they sell soured loans, as policy makers tackle a 1.1 trillion-euro ($1.2 trillion) bad-debt mountain they blame for stifling growth.

Officials in Brussels are looking into allowing struggling lenders that are trying to sell impaired assets to qualify for a so-called precautionary recapitalization, whereby state aid can be given to a solvent firm. That could smooth the way for bailouts in the EU’s hardest-hit countries, including Cyprus, Portugal and Italy.

This goal must be squared with EU law, which stipulates that the need for “extraordinary public financial support” normally means a bank is failing and should be wound down. An exception is made for temporary state aid to address a capital shortfall identified in a stress test if a number of conditions are met.

Andrea Enria, head of the European Banking Authority, has led the charge to allow public support for banks struggling to unload bad loans. He told EU lawmakers on April 25 that precautionary recapitalization could be used to “deal promptly and decisively with the significant legacy of asset-quality problems in the European banking sector, which remains a drag on the EU economy.”

Impaired Assets

That’s consistent with the thinking of some senior officials in the European Commission, the EU’s executive arm, who said in a presentation seen by Bloomberg that it “seems conceivable to provide a bank with aid in the form of precautionary recap to finance an impaired-asset measure.”

A spokeswoman for the commission declined to comment on the document.

Enria has proposed setting up an EU-wide bad bank to take over and manage the sell-off of firms’ soured loans by bridging the gap between the “real economic value” of the assets and the price that investors are willing to pay. While this bloc-wide proposal hasn’t gained much traction, EU finance ministers earlier this month gave “broad support” to plans for developing national asset-management companies based on a common blueprint.

In their Feb. 24 presentation, the European Commission’s Mario Nava and Gert-Jan Koopman said state aid could be used to finance the purchase of nonperforming loans by an asset-management company above market price and to provide the bank with capital “to cover losses coming from sale of NPLs.”

Nava and Koopman noted that all the conditions on precautionary recapitalization in the EU’s Bank Recovery and Resolution Directive and state-aid rules would have to be observed. Under BRRD, which is intended to make investors, not taxpayers, pay for bank failures, such support can’t be used to offset incurred or likely losses, for example.

‘Negative Results’

Even if the precautionary aid can cover all losses generated by the impaired-asset measure, a bank might still need more capital to return to viability, Nava and Koopman wrote. “In that case, the measure cannot be approved under state-aid rules.”

Gunnar Hoekmark, the lawmaker who led BRRD through the European Parliament, said state aid could be allowed under the law for this purpose.

“Precautionary recapitalizations were not meant to compensate for negative results in a bank, they are there to provide stability in a stress situation,” he said in a telephone interview. “Depending on the situation, the fact that a bank needs to deal with nonperforming loans can be part of this stability.”

Yet part of the problem with nonperforming loans is that BRRD allows little flexibility for governments that want to intervene to stabilize a bank that, while legally solvent, is nevertheless in “troubled waters,” as Daniele Nouy, head of the European Central Bank’s oversight arm, has put it.

‘Low Profitability’

Enria developed that logic: “You might have situations in which a bank or a number of banks are not failing or likely to fail, but with their balance sheet full of nonperforming loans they’re unable to serve their customers as they should, they have very low profitability and remain sort of underperforming banks for a long period of time,” he said.

In such cases, authorities would benefit from having the power to “deploy some amount of state aid to help the process to move forward,” he said.

This idea may prove a tough sell in Berlin, where the German Finance Ministry has been skeptical about Italian plans to bail out banks with high levels of bad loans, including whether money would be used to cover losses. And a growing number of critics wants the precautionary recapitalization provision to be overhauled or even removed from BRRD.

“If you allow state aid one last time to get rid of the legacy NPL problems, it would only be worth supporting if you would at the same time get rid of the precautionary recapitalization for good,” said Christian Stiefmueller of Finance Watch, a Brussels-based watchdog group. “You’d say, ‘Once we’re done with this, there’s only resolution.”’

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