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The writer is chairman of the supervisory board of the European Central Bank
In recent weeks, moratoria on bank loans have expired in some EU countries and, anecdotally, payments have resumed with only a small fraction showing distress. Yet the macroeconomic outlook is uncertain and we cannot rule out a weak recovery with a significant build-up of bad loans.
The European Central Bank estimates that in a severe but plausible scenario non-performing loans at euro area banks could reach €1.4tn, well above the levels of the 2008 financial and 2011 EU sovereign debt crises. While we can hope for the best, we must prepare for the worst. We also must do better than in previous crises.
The banking union helps make this possible, with asset management companies the tool that will allow us to avoid past mistakes. First, we need to be faster in dealing with NPLs: 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. New legislation also ensures progressive writedowns of impaired assets. Yet experience shows that when asset management companies were used after the crises, bank balance sheets have been cleared up quicker with a more effective restoration of banks’ ability to lend.
We also 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 crises. But Europe was ineffective in using consolidation to remove excess capacity and foster a radical refocusing of business models. The result today is a fragile EU banking sector, with rock bottom equity market valuations. By contrast, asset management companies can combine support with appropriate conditionality to banks saddled with NPLs, delivering much-needed improvements to their business models.
Last, we need an integrated European response rather than a plethora of uncoordinated national initiatives. EU banks are segmented along national lines, making them less efficient and more fragile. The pandemic’s exogenous and symmetric shock creates favourable conditions for a European initiative. This is not about helping banks that took excessive risks and managed them poorly. Instead, the aim is to enable EU banks to support viable households, small businesses and companies, and to bolster the EU’s needed transformation to a greener and more technologically advanced economy without banks being weighed down by impaired loans.
A European asset management company is an effective solution. Alternatively, a network of national asset management companies could also support economic recovery, if appropriately designed. To work, at least two elements of any network would have to be anchored at the EU level: funding and pricing. With funding provided or guaranteed by a central body, each national asset management company, regardless of location, would benefit from the EU’s credit standing and enjoy better market access.
At the same time, the pooling of financial resources calls for standardised valuation methodologies and data to determine the price at which NPLs are transferred from banks to the asset manager. This combination would help ensure the right balance is struck between losses imposed on banks when they transfer NPLs to the relief scheme, and the scheme’s medium-term profitability. Direct access to the scheme should be limited to banks that, in their supervisor’s opinion, have a viable business model and can thrive as standalone entities when the crisis ends.
Other banks can participate subject to strict conditionality, including decisive restructuring. In the unlikely case that such a scheme ends up making losses, we could limit or even prevent any mutualisation of them across the EU. Instead, losses could be allocated by the nationality of the originating banks and each corresponding national scheme. We are convinced such an initiative can be designed by leveraging the flexibility of the EU’s current legal framework and state aid rules. However, we must be prepared to make legislative adjustments, if necessary. The stakes are high: we cannot afford to have a banking sector that struggles with the debris of the current crisis for years to come. Nor can we afford a banking sector that is unable to support our economies’ transformation.