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The assessment of credit risk is a critical part of the macro-prudential analysis, with the aggregate non-performing loan (NPL) ratio serving as a proxy for the economy-wide probability of default of the banking sector’s overall loan exposure. High NPL ratios impact on banks’ balance sheets and profitability, overall slowing down economic growth. Therefore, the factors driving NPL ratios in different EU countries have gained a lot of interest in recent years. NPL ratios in countries like Italy, Portugal and Spain have sharply started to come down, even if this has made less headline compared to the dread over NPLs’ accumulations up until recent. In the context of European Union member states, reducing the stock of NPLs is seen, particularly by Germany, as an essential step before further risk sharing mechanisms, including mutualisation, can be granted and for the very completion of the Banking Union (BU).
In this context, there’s been little progress since the Single Resolution Board guarantee, as there remain significant obstacles weighing against reaching an agreement for a European Common Deposit Scheme, as the third pillar for a fully-fledged Banking Union for Europe. One of the soundest arguments is that the traditional banking system remains destabilised, particularly in the EMU periphery, as evidenced by the persistence of “home bias” and a much uneven distribution of NPLs. The latter is currently seen as the main obstacle for the consolidation of a deposit insurance mechanism which would limit banks’ liquidity and solvency risks, because of moral hazard concerns.
The process of deleveraging of the southern periphery’s banking system is on its way, mainly through outright institutional and government intervention (e.g., in Italy with the help of government guaranteed agencies; see European Parliament, 2018). However, the search for yields in a low-interest rate and low growth environment is pushing banks to increase their holding of home government bonds, adding to the fragility of the banking system in the southern (euro area) periphery, and increase risky lending, which may intensify yet again the possibility of increasing NPLs in the future. This risk may materialise at the point the ECB will have, sooner or later, to pull the plug on the unconventional monetary stimulus.
There is a lot of uncertainty regarding the evidence on the current stock of NPLs, as the Bank for International Settlements (BIS) introduced only a few years ago a framework for the harmonisation of NPLs’ measurement. While discrepancies exist in the actual level of deteriorated loans on the balance sheets of European banks, the BIS and the International Monetary Fund (IMF) data would still agree on the trend. The literature on NPLs in Europe typically identifies several determinants of NPLs, including banks’ specific factors, as well as macroeconomic factors such as real GDP growth with no specific different determinants being identified even when the analysis is carried out in the traditional core-periphery sense across the euro area.
In looking for evidence about the extent of NPL accumulation and distribution across the EU, authors construct quarterly NPLs series from the IMF quarterly Financial Soundness Indicators, which they compiled over the period 2007:Q1– 2018:Q3, by cross-checking them with the European Bank of Reconstruction and Development (EBRD) quarterly data and the IMF/World Bank Financial Indicators Annual data. By comparing the euro area with EU non-euro area countries, starting from high NPL levels, credit quality has continued to improve in many countries, with different turning points in the negative spiral of NPL accumulation. The turning point has to be understood as the period after which deleveraging has started.
Among these, one can identify three groups of countries: a first group (Group 1) with no significant accumulation in NPLs during the last decade (Belgium, Germany, Denmark, Finland, France, Luxemburg, the Netherlands, Sweden, UK), a second group (Group 2) in which low levels of initial NPLs have been accompanied by moderately high increases during the crisis (Austria, Czech Republic, Estonia, Spain, Hungary, Lithuania, Latvia, Poland, Slovakia), and, finally, a third group (Group 3) in which high levels of NPLs were observed since the early pre-crisis and have persisted ever since (Bulgaria, Cyprus, Greece, Croatia, Ireland, Italy, Malta, Portugal, Romania, Slovenia). Interestingly, except Bulgaria and Romania, all countries in Group 3 share the single currency.
As one can see, countries with historically low NPLs have kept accumulating those – last, Luxemburg and Finland – with minimal marginal variations on the NPLs ratios (Group 1, in green). Countries who experienced moderate increases, however, started the deleveraging quite early on, with the last EU-country to deleverage being Czech Republic (Group 2, in yellow). Among the third group, the countries that have started the deleveraging late remain the most problematic, with all of them being concentrated in the second half of the sample, hence having started the restructuring process later. Now that the deleveraging has begun, particularly with very steep decreases in countries such as Italy, Portugal and Spain, there seems to be less urge to discuss those experiences, and particularly which lessons, if any, one can learn from Central Eastern European countries. However, despite the general (and in some cases tardy) improvement, NPLs remain very persistent in some EU countries.