After much lobbying, guidelines for banks become “non-binding expectations,” says the ECB.
Banks in Europe have won yet another key regulatory battle, and once again largely at the expense of Eurozone citizens, both in their role as taxpayers and bank customers: How to deal with their bad loans.
These non-performing loans (NPLs) are a long-festering massive problem at European banks. At most recent count, the total was estimated to be €759 billion, or 5.15% of total loans. By comparison, the NPL ratios in the US and UK banking sectors in 2016 were 1.3% and 0.9%, respectively. Currently six (out of 19) Eurozone countries have an NPL ratio above 10%:
- Ireland: 12.8% (down from 15.8%)
- Italy: 11.8% (down from 16.6% in 2016)
- Portugal: 18.2% (down from 19.2% in 2016)
- Slovenia: 13.6% (down from 19.7% in 2016)
- Greece: 46.6% (no change since 2016)
- Cyprus: 34.0% (down from 49% in 2016)
After years of promising sweeping reforms to finally address the NPLs in various stages of decay on EU banks’ balance sheets, the European Commission and European Central Bank have unveiled a regulatory packagewith little teeth but lots of sweeteners (for the banks).
The reform package has four main goals:
- To ensure that banks set aside enough funds to cover the potential risks posed by loans going sour in the future.
- To encourage the development of secondary markets where banks can sell their NPLs to credit servicers and investors.
- To facilitate debt recovery, as a complement to the insolvency and business restructuring proposal put forward in November 2016. This is particularly important in countries like Italy where it can take years to recover unpaid debt.
- To provide Member States with a blueprint, albeit non-binding, on how to establish Asset Management Companies (AMCs) or other measures dealing with NPLs.
On the surface these reforms may sound reasonable, perhaps even laudable, but in reality they represent a retreat from an earlier proposal for more robust treatment of bad debt. For years the ECB had promised tough measures on NPLs. But last November, the European Parliament accused the ECB of overstepping its authority by planning to impose “binding rules of general scope applicable to all banks” that is supervises.
Banking lobbies and some national governments, including Italy, feared that tough regulatory measures would have a negative impact on domestic lenders, and they lobbied furiously to prevent that from happening. Judging by the latest policy announcements, they got their way.
The ECB’s long-delayed guidelines on new non-performing loans are due to go into effect on April 1, but the supervisor has already said it will hold off for several years before forcing lenders to actually build provisions for loans going bad after its cut-off date. According to the guidelines, banks will have two years to fully provision for bad non-secured debt. For secured loans the deadline will be as long as eight years.
In another deviation from its original proposal, the ECB will ask for provisions on secured debt only from the third year, instead of a linear build up. “The ECB is still shying away from moving quickly on addressing NPLs,” saidGuntram Wolff of Brussels-based think tank Bruegel. “It is important to give time, but another two-and-half-year delay is bad news for returning Europe to full health.”
The ECB also said the guidelines were “non-binding expectations” and would merely serve as the basis for case-by-case dialogue with banks on how they provision against bad debt.
In sum, lenders will not be treated consistently by regulators, the guidelines are non-binding and, in any case, will not come into effect until at least 2021 just to begin getting their books in order. “Banks should use the time to prepare themselves and also to review their credit underwriting policies and criteria to reduce the production of new non-performing loans (NPLs), in particular during the current benign economic conditions,” said the ECB in a statement.
While the banks have been granted a two-and-a-half year breather on making changes, during that time they could end up getting a big helping hand from EU taxpayers. Among its guidelines on setting up bad banks or asset management companies that would buy bad loans from banks is one that effectively allows state aid to set up these entities is allowed, but under certain conditions and as “an exceptional solution.”
This policy measure sounds eerily similar to a proposal put forward last February by the ECB Vice President Vitor Constancio for the creation of a whole new class of government-backed “bad banks” to help buy some of the bad loans, which itself bore a striking resemblance to a plan presented last year by the European Banking Authority (EBA) for the creation of a massive EU-wide bad bank.
One of the biggest advantages of launching this initiative at EU-level is that it will avoid the sort of public “resistance” that would occur if it is done at a national level, said EBA president Andrea Enria. Lenders will presumably be able to price their bad loans higher than their market value — and the difference between the price investors pay for the bad debt and the price the banks end up receiving will be covered by Europe’s unsuspecting taxpayers rather than bank investors. By Don Quijones.