The time is ripe to clean up euro zone banks’ bad loans

Opinion piece by Danièle Nouy, Chair of the Supervisory Board of the ECB, published in the Financial Times on 30 November 2017

The financial crisis of 2007-08 woke Europe — if not the world — up to the fact that bank collapses no longer stop at national borders. Banking union, the response of eurozone countries to the crisis, has provided a common approach to supervising and resolving banks.

Banks are now far better capitalised and equipped to assess and mitigate risk. Yet ten years on from the crisis, the legacy of poor lending decisions and inadequate oversight still haunts us. A number of banks across Europe are heavily burdened with bad loans.

At the end of June, eurozone banks were weighed down by a total of €794bn of bad loans. Banks that are bogged down by bad loans are unable to fulfil their important role of providing credit to the economy. This cannot be solved overnight. But the costs of inaction are palpable, which is why pressing for action is one of the European Central Bank’s top priorities.

The good news is that progress is being made: the average rate of non-performing loans fell to 5.5 per cent by mid-2017, down from 6.6 per cent a year earlier. But there are still large discrepancies between individual eurozone banks. Some banks benefited from taking early action; others were forced under post-crisis programmes to clean up their balance sheets; yet others have lagged behind and could do far more.

Now is the time to act. We have seen 18 consecutive quarters of economic growth. This is exactly the time for banks to use all the means at their disposal to reduce the burden of bad loans, including curing troubled loans, recovering cash, and writing them off or selling them.

As supervisor of the euro area’s biggest banking groups, it is the ECB’s job to scrutinise banks’ reduction plans and their capital and provisioning levels. We provide advice regarding best practice, as we did earlier this year with the qualitative guidance on designing ambitious but realistic strategies to reduce banks’ bad loans. In a stocktake, we also pointed out the judicial and legal obstacles, which are an impediment in some countries to resolving bad loans in a timely manner, as well as the under-developed secondary markets or platforms to sell soured loans.

We then outlined what we expect from banks in quantitative terms with regard to future bad loans — essentially, how long the ECB expects a bank to take before it sets aside additional capital. The Bank is consulting all stakeholders on this guidance, which is designed to help prevent a renewed increase in such loans. This has led to some myths and misinterpretations — from accusations that the ECB is exceeding its role to suggestions it should direct its efforts elsewhere.

The ECB’s planned guidance will be applied on a case-by-case basis. There is no automatic application. We will assess each bank’s specific risk profile and look closely at the bank’s books and understand its business before forming judgments. Potential measures will be based on this individual supervisory assessment.

As supervisor, the ECB has a legal obligation to address vulnerabilities in the banking sector, for example by assessing the credit risk provisioning used by banks. These complement the minimum regulatory requirements set by lawmakers. And by issuing public guidance, the ECB fulfils its obligation to be transparent about our administrative practices to ensure banks’ compliance with the law.

Our guidance is in line with the eurozone finance ministers’ agreement in July this year on a comprehensive strategy to tackle the issue of non-performing loans as part of a wider strategy of risk reduction in the financial sector. All stakeholders — can do their bit to help. Not doing so could be construed as a failure to learn the lessons of the financial crisis. Within its supervisory remit, the ECB is playing its part.