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The European Banking Union (EBU) was created after the Eurozone crisis to complete the missing elements of the euro architecture and help stabilise the banking sector. Its main pillars (already established) are the Single Supervisory Mechanism (SSM) introducing common supervision, and the Single Resolution Mechanism (SRM) introducing appropriate resolution tools and most importantly the bail in principle. A third pillar on the need for a European Deposit Insurance Scheme (EDIS) is being broadly discussed.
So, which is the most important problem of the Eurozone banking sector that has not yet been addressed properly? The answer is the huge stock of Non-Performing Loans (NPLs). NPLs exceeded 6.6% of all loans in 2016 compared to 1.5% in the US. Total NPLs were close to 1 trillion euro, while uncovered (after considering provisions) NPLs were more than six times the annual profits of European banks.
Especially for a group of six countries (Cyprus, Greece, Italy, Ireland, Portugal and Slovenia) NPLs reach 22.8% and can be interpreted as a clear sign of fragmentation in the Eurozone banking market. By being a drag on bank profitability, NPLs constrain credit expansion, endanger financial stability and delay economic growth. NPLs are also closely related to the problem of debt overhang hindering highly leveraged firms to ask for credit in order to finance investment. In addition, non-viable firms may be kept alive by already committed banks while at the same time viable firms suffer from lack of funding and unhealthy competition. Thus, recovery is further delayed by zombie-lending, as it is often called.
A pan-European asset management company (EAMC) as suggested by Emilios Avgouleas and Charles Goodhart (among others) may be the most effective approach for managing the accumulated delinquent assets in the Eurozone. The EAMC can be a holding company of national AMCs and funded through proportionate contributions by member states and private funds. Strong uniform governance links will connect the EAMC with its subsidiaries avoiding redistributive outcomes. The price at which the impaired assets will be transferred can be a combination of their book value excluding provisions, their real (long-term) economic value and their market value.
Thus, a more balanced valuation will take into account the potential rise in market prices once the economy rebounds. Profit and loss agreements between the banks and the AMCs can be accompanied by an ESM guarantee within the framework of the ‘precautionary recapitalisation’ process and a respective conditionality on their business plans. The EAMC has a comparative advantage for establishing a centralised platform (recently announced by the ECB) where information sharing and direct sales of assets can take place, facilitating the function of the secondary NPL market and boosting liquidity.
Consequently, an EAMC could be an efficient way to faster reduce the stock of NPLs and lead to much needed increases in investment and growth in the Eurozone. One could see it as a fourth pillar missing from the current structure of the EBU, but it remains to be seen whether the EBU’s architects can be convinced of its necessity.