Editorial Board

A 'Bad Bank' Could Be Good for Europe

If only Germany would agree.

Time for a reckoning.

Photographer: Ralph Orlowski/Getty Images

Some European regulators have come up with a viable plan to alleviate the region’s chronic financial paralysis. If only European politicians, particularly in Germany, would listen.

QuickTake Zombie Banks

The European Union’s leaders have spent much of the past decade debating -- but never fully resolving -- what to do about the huge pile of bad loans that EU banks are sitting on, most recently estimated at more than 1 trillion euros. Nobody knows how large the losses will ultimately be, and this uncertainty spooks investors, inhibits new lending and undermines the European Central Bank’s efforts to support economic growth.

Now, a group of officials at the European Banking Authority -- with the support of colleagues at the ECB and the euro area’s bailout fund, the European Stability Mechanism -- has put forth a proposal that could help: Create a publicly funded, pan-European “bad bank.” Its aim would be to dispel uncertainty by determining the fair value of the soured assets and, with the help of private investors, purchasing a large portion of them.

The plan has several advantages. By forcing banks to recognize losses, it could trigger a much-needed restructuring of Europe’s overcrowded banking sector: Unhealthy banks would have to either raise more capital or shut down. By averting a fire sale into illiquid markets, the plan would limit system-wide losses and make the whole reckoning less painful. The bad bank could even turn a profit for the European governments that provided its capital.

Unfortunately, the EU’s largest member, Germany, has withheld support for the plan, apparently on concerns that its contribution would go toward bailing out banks in other countries. To which one can only ask: That’s the point, isn’t it? Part of the purpose of a pan-European bad bank is to enable the kind of risk-sharing needed to make Europe’s banking union and common currency viable. The plan’s concession on this score -- if the bad bank can’t sell assets for at least the price it paid, it can claw back the difference from the relevant bank or national government -- is a weakness, not a strength.

Germany’s intransigence is misguided. The country’s officials are rightly skeptical that Europe’s new financial supervisory system -- which was centralized under the ECB in 2014 -- will be tough enough to force closures and restructurings. Yet by opposing a European bad bank, they are depriving supervisors of an opportunity to do exactly that.

Granted, a lot depends on execution. The plan shouldn’t delay Italy’s ongoing effort to shore up its banks, and it should require all banks to raise the equity capital needed to make the whole system more resilient. If that’s the goal, then Germany should give it a chance.