Editorial Board

Europe Needs to Face Its Bad-Loan Problem

Banks in the European Union should recognize their losses more quickly.

Half a plan is better than none.

Photographer: Ralph Orlowski/Getty Images

Financial regulators in the European Union are grappling on several fronts with problems in their banking system. They’ve made some progress, but there’s a pattern: The proposals fall short. Plans for EU-wide deposit insurance have been watered down. The system for resolving failing banks is underfunded. And now controversy has arisen over new rules for dealing with bad loans -- rules that, despite the complaints, still aren’t as bold as they ought to be.

The European Central Bank wants lenders to recognize non-performing loans sooner, and make adequate provision against them. That would be good, because it would make banks financially stronger when the next downturn comes round.

As they stand, though, the new rules would apply only to new non-performing loans, not to those already on the banks’ balance sheets. Thanks to the crash, the existing stock stands at nearly a trillion euros -- and to speed up the European recovery, this needs to be addressed.

The proposal would allow the ECB’s supervisory arm to demand that, over time, a bank set aside 100 percent of the value of loans that go bad in future. The plan is part of a global move toward recognizing losses more promptly. Up to now Europe has lagged behind the U.S. in this regard: American banks have  recognized their losses more aggressively.

Banks and politicians have criticized the proposal, saying it will make credit more expensive. They have a point: Some companies may need to pay more for their loans. Nonetheless, it makes sense for the ECB to act now. Much like their U.S. rivals, Europe’s lenders made inadequate provisions against bad loans before the financial crisis hit. With recovery firmly under way, it’s time to ensure banks aren’t caught off-guard again.

The problem isn’t that the rules are too tough, but rather the opposite: Europe also needs to deal with the existing stock of non-performing loans. This is both a threat to financial stability and an obstacle to growth, since it absorbs capital that could be supporting new investment.

Not before time, European banks are now speeding up their disposal of bad loans. As the recovery gathers pace, they’ll be able to get a higher price, which will help. But many small lenders, especially, are still reluctant to face their losses. This would reveal a hole in their balance sheets that investors may be unwilling to fill with new capital. The answer is consolidation -- stronger banks taking over weaker rivals, with lenders that can’t find a buyer wound down.

Supervisors need to move this restructuring forward, not get in its way. Forbearance and timidity are the enemies of sound financial regulation. Even now, it’s a lesson that Europe’s regulators haven’t fully learned.

    --Editors: Ferdinando Giugliano, Clive Crook

    To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net .

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