Non-performing loans across the European countries
The institutional framework for defining non-performing loans
The recent global crisis has left many banks across Europe with a high volume of non-performing loans (NPLs hereafter) in their balance sheets. NPLs in the European Union grew significantly between 2009 and the time of writing this note, and their levels remain particularly high in the southern part of the Eurozone, as well as in several eastern and southeaster European countries (Aiyar et al., 2015). Consequently, the problem of NPLs has been classified as a regulatory priority by the European Central Bank (ECB hereafter), the Joint Supervisory Teams, and the national competent authorities (ECB, 2017a,b). One of the problems has been the lack of uniformity and clarity of how to recisely define a NPL. This is important because it resulted in the general recognition that banks did not appropriately provisioned and recorded credit losses, i.e. they did it “too little, too late,” which contributed to post-crisis instability.
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The recovery of the Eurozone (EZ) economy has made even more pressing the tackling of its debt overhang with the bulk of over 1 trillion Non-Performing Loans (NPLs) concentrated in the more vulnerable economies of the EZ periphery. There is clearly a need to adopt a more radical approach to resolving NPLs than merely augmenting supervisory tools and national legal frameworks. The discussion about the feasibility of country-based or Pan-European Asset Management Companies (AMCs) to tackle legacy NPLs has recently intensified. Yet political objections premised on fears of debt mutualisation, the structural and legal questions surrounding the possible establishment of AMCs, and differing recovery rates and levels of market transparency within the EZ have led to the dismissal of the idea by the European Council. This article discusses the merits and shortcomings of AMCs in tackling NPLs and proposes a comprehensive structure for a Pan-European “bad bank” with virtually ring-fenced country subsidiaries to ensure burden sharing without debt mutualisation. The proposed “bad bank” structure intends to resolve a host of governance, valuation, and transparency problems that would otherwise surround a “bad bank” solution. Also, the proposed scheme is in effecoctive compliance with the EU state aid regime and could lead, if implemented, to the alleviation of the EZ debt overhang to stimulate credit growth.
The current overhang of NPLs in Europe is not exceptional in a historical perspective. However, despite the wealth of experience in NPL resolution accumulated after earlier crisis episodes, resolving Europe’s NPL problem continues to be a thorny issue. Difficulties reflect the chronic nature of the NPL malaise this time round but also the widely differing perceptions about the upside that NPLs may still present. For these reasons, NPL stocks are unlikely to decline fast and the costs of delayed action continue to accumulate. A number of promising resolution schemes – involving specialised asset management companies, specialised servicers, and/or securitisations – have been put forward. To be effective, these schemes will require hard policy choices to be made.