ECB puts heat on banks: non-performing loan volumes shall be reduced faster.

Non-performing loan volumes amongst European banks have been going down since 2016 – but too slowly, according to the European Central Bank (ECB). It now has its sights set on the bad debts residing with financial institutions and wants to see significant results within seven years.

For Italy’s Deputy Prime Minister, Matteo Salvini, this amounted to an “attack” on his country’s banking system: the Italian bank Monte dei Paschi announced in January that the European Central Bank (ECB) had recommended to set aside reserves in the next seven years, so that by the end of 2026 it will have fully provided for all of its non-performing loans (NPLs). Investors as well as politicians were alarmed: the ECB clearly wants to increase the pressure on banks to divest themselves of their bad debts. Meanwhile, Italian banks’ share prices plummeted.

Until now, the ECB has only set this kind of time frame for more recent non-performing loans: unsecured NPLs accrued since 1 April 2018 should be fully covered by reserves on the bank’s balance sheet within two years, secured NPLs should be settled in full in five stages over a period of seven years.

It now emerges that the ECB is considering similar rules for bad debts relating to NPLs. In July, the ECB announced that the “supervisory approach” for older NPLs would follow “the work already done in this area”:  in the “medium-term”, old and new non-performing loans should be “equally covered” within the risk provision.

Central Bank insists on the right and duty to supervise

The ECB's intention is politically controversial. In autumn 2017, the President of the European Parliament, Italy’s Antonio Tajani, criticised the Central Bank's guidelines and questioned its jurisdiction regarding the issue of non-performing loans. The ECB responded by stating that, as banking supervisor, it has every right and duty to agree individual targets for reducing NPLs for each of the banks it supervises.  

According to the ECB, the new guidelines should be seen by each bank as a “proposal”, which may be modified where there is good reason to do so. Thus, not all banks will need to inevitably completely write off their non-performing loans within seven years. However, in 2021, the ECB wants to assess the “supervision dialogue”, which is why it advised in March 2018 that: “banks should use the time to prepare appropriately.”

In its risk assessment for 2019, the ECB classifies non-performing loans - together with geopolitical uncertainty and cyber criminality - as one of the three greatest risks for the banking system in the Eurozone. The pressure on Europe’s banks is boosting NPL package trading. The Hamburg-based EOS Group thus purchased various credit portfolios in Eastern Europe last year. In Spain, the nominal value of just one portfolio purchased by EOS from Abanca amounted to 476 million euro.

There are no signs of an end to this trend: bad loans amounting to some 714.3 billion euros remain dormant on the books of European banks, even though the ratio of non-performing loans to overall credit volumes has reduced from 8% to 4.17%. However, when making international comparisons, that figure is still high: according to the World Bank, volumes in the USA, where the financial crisis began with the sub-prime catastrophe, are just below 1.2%.
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