16 February 2022

SUERF: The COVID Non-Performing Loan ’Tsunami’ that Never Happened and How to Avoid it Now

Initial fears of rapidly worsening bank asset quality and an ensuing ‘Non-Performing Loan (NPL) tsunami’ from the COVID-19 pandemic have not materialised so far. In Europe, this is mainly due to the unprecedented mix of policy support measures that European governments have implemented...

In early 2020, many feared that the Covid-19 pandemic would lead to a huge rise in Non-Performing Loans (NPLs) in Europe and other parts of the world. Despite the steep recession caused by the pandemic in 2020 and the uneven recovery since then, these predictions have been proven wrong. In fact, NPLs in many European countries have declined to a historic low. How has the widely feared NPL tsunami been avoided in Europe, a continent that struggled so long with NPLs in the wake of the twin global financial crisis in 2008/9 and the eurozone crisis in 2011/12? And what can policy makers and business do to make sure that NPLs are also kept at bay in the future? We identify key factors at play that explain the unexpectedly benign developments so far and suggest additional policy measures both at the national and the EU level to avoid the re-emergence of a large-scale NPL problem, as the remaining policy support measures are being withdrawn.

The European NPL landscape had much improved by the time the pandemic started

On the eve of the pandemic, the euro area and the rest of the EU had made a lot of progress in dealing with the previous wave of NPLs resulting from the GFC and the euro area sovereign debt crisis. NPL levels had fallen substantially from their peaks, banks were better capitalised, regulators had introduced more stringent and consistent definitions for problem assets, and supervisors tightened their approach towards NPL management.
Progress was also made towards improving the resolution system, though it remained a mix of national and EU-level measures (with an emphasis on the former) and was never seriously tested. Overall, the euro area NPL ratio peaked in 2014 at just over 8 percent, before declining to 3.6 percent in 2019. In some euro area countries, however, NPL ratios remained substantially higher (Figure 1).

Figure 1: NPL ratios in the euro area and selected euro area countries, 1998-2021

Notes: EA refers to the euro area in 2019 composition. EA6 is the weighted average figure for Cyprus (CY), Greece (GR), Ireland (IE), Italy (IT), Portugal (PT), and Slovenia (SI). Other highlighted countries in the chart are Spain (ES), Latvia (LV), and Lithuania (LT).

This decrease in NPLs was partly due to specific policy measures to deal with them. The European Banking Authority (EBA) agreed in 2013 to a uniform EU-wide definition of NPLs (EBA 2013). This significantly strengthened the measurement and comparability of NPLs across the EU and even beyond, as neighbouring European countries also adopted them under the Vienna Initiative.

The ECB’s Comprehensive Assessment (CA) of the euro area banking system in 2014, comprising an asset quality review and a solvency stress test for 130 significant euro area banks, helped to clarify the true extent of the problem at the time (ECB Banking Supervision 2014).

The Single Supervisory Mechanism (SSM, often referred to as ECB Banking Supervision) established in 2014 led various NPL initiatives, culminating in the adoption of an EU Council Action Plan on NPLs in July 2017. This covered a wide range of policy objectives and recommendations on supervisory tools, macroprudential approaches, secondary NPL markets and targeted structural reforms.2

A “whatever it takes” policy mix – with EU characteristics

As the world economy plunged into a deep (though brief) COVID-induced recession, the general expectation was that bank asset quality would rapidly worsen and an NPL tsunami would follow. Yet the expected NPL shock has not materialised, and almost everywhere in Europe the level of NPLs is the lowest on record.

This is primarily thanks to the adoption of a new, “whatever it takes” policy mix – with special EU characteristics. Globally, the innovation of this pandemic-induced policy mix was not just its unprecedented stimulus size and the coordination between fiscal and monetary authorities, but also the fact that it included, for the first time, specific anti-cyclical, macroprudential measures. Regulatory forbearance was used before as part of crisis response, but this was the first time that the relaxation of macroprudential measures became an important part of the policy package.

In Europe, putting the support measures in place required the removal of key legal and regulatory obstacles at the EU level. The EU’s fiscal rule – the Stability and Growth Pact (SGP) - has been suspended since March 2020, along with state aid and competition rules.3 The discretionary acceptance of deviations from the SPG, and the discretionary easing of some state aid and competition rules has happened before. But there was no precedent for the synchronised mix of fiscal, monetary, and regulatory anti-cyclical policies deployed at the national and the regional EU level in response to the pandemic.

Direct and indirect fiscal support by EU member states ranged between a few percentage points to double digits of GDP. Overall, the EU member states provided a total of about 27% of GDP in 2020-21 to date (as a share of 2019 GDP), with the share of guarantees/contingent liabilities even higher than direct fiscal support (Figure 2). The overall size of fiscal support in the EU and the US have been broadly comparable at about 25-27 percent of GDP in the matter of 18 months, but in the US most of the support was in the form of direct fiscal stimulus.

Figure 2: Fiscal support measures in the EU and the US, 2020-21


Sources: IMF Fiscal database June 2021 and EIB data.

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