Bank asset quality: this time we need to do better

Opinion piece by Andrea Enria, Chair of the Supervisory Board of the ECB, a short version was published in the Financial Times on 27 October 2020

27 October 2020

In the last few weeks, moratoria on bank loans have expired in some EU countries. Anecdotal evidence shows that customers are resuming payments, with only a small fraction showing signs of distress. Yet the macroeconomic outlook is rife with uncertainty and we cannot rule out a weak and protracted recovery with a significant build-up of deteriorated assets. According to ECB estimates, in a severe but plausible scenario non-performing loans (NPLs) at euro area banks could reach €1.4 trillion, well above the levels of the financial and sovereign debt crisis.

While we hope for the best, we must be ready for the worst. This time we need to do better than in the aftermath of the previous crisis. The banking union should make this possible. And asset management companies could be the tool that enables us to avoid repeating past mistakes.

First, we need to be faster in dealing with NPLs. Twelve years after the default of Lehman Brothers and nine years after the first private sector involvement during the Greek sovereign debt crisis, asset quality at euro area banks has still not reached pre-crisis levels. Granted, there has been some progress: the European Banking Authority and the ECB have developed practical guidance that requires banks to manage NPLs more actively, and legislation has been introduced to ensure progressive write-downs of impaired assets. However, the experience of the past shows that whenever asset management companies were used, the clean-up of bank balance sheets was much quicker and more effective in restoring banks’ ability to lend.

Second, we need to use this opportunity for a deeper restructuring of the banking sector. Vast amounts of taxpayers’ money was deployed in the aftermath of the financial and sovereign debt crisis, but we were not effective in removing excess capacity and fostering a radical refocusing of business models and more consolidation. The result is a banking sector that is structurally fragile, as reflected in the rock bottom valuations in equity markets. Asset management companies can combine support to banks saddled with NPLs with appropriate forms of conditionality, delivering a much-needed improvement in the viability of business models.

Last but not least, this time we need an integrated European response rather than a plethora of uncoordinated national initiatives. This coordination failure left us with the heavy legacy of a banking sector that was segmented along national lines and thus less efficient and more fragile. The exogenous and symmetric nature of the shock triggered by the pandemic should create favourable conditions for an agreement on a European initiative. This is not about helping banks which took excessive risks and did not properly manage them. Instead, the policy objective is twofold: to enable banks across the European Union to support viable households, small businesses and corporates, and to accompany the much-needed structural transformation of our economies towards a greener and more technologically advanced future without being weighed down by impaired exposures to the economic sectors worst hit by the crisis.

I am convinced that a European asset management company would be an effective solution. Alternatively, a European network of national asset management companies, if appropriately designed, could equally support a symmetric recovery of our economies. I strongly believe that at least two elements of such a network need to be firmly anchored at the European level: funding and pricing. If the funding is provided or guaranteed by a European body, each national asset management company, regardless of its location, would benefit from the EU’s credit standing and be able to access markets on better terms. However, common financial resources, with all their attendant benefits, also call for appropriately standardised and verified valuation methodologies and data to determine the transfer price of the assets. The low cost of funding and a carefully designed and verified common valuation methodology would ensure the right balance between the losses imposed on banks upon transfer of the NPLs and the medium-term profitability of the asset relief scheme.

Direct access to the scheme should be limited to those banks that, in the opinion of their supervisor, have a viable business model, enabling them to thrive as standalone entities when the crisis is over. For other banks, participation should be based on strict conditionality, including decisive restructuring measures.

In the unlikely case that such a scheme ends up making losses, it is possible to design a framework that limits or even excludes any mutualisation of credit losses across the European Union: losses could be allocated in accordance with the nationality of the originating banks and the corresponding national scheme.

We are convinced that such an initiative could be designed, leveraging the flexibility of the current legal framework and State aid rules. However, we should also stand ready to make legislative adjustments, if necessary. The stakes are too high: we cannot afford a banking sector struggling with the debris of the current crisis for many years to come. And we cannot afford a banking sector unable to support the transformation of our economies.

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