The European Union unveiled plans to assist countries in setting up a network of national “bad banks” to help cope with a possible avalanche of defaulted loans triggered by the pandemic.
Bad banks—private or government funded repositories that soak up soured loans—are seen as a way to help Europe’s creaky banks navigate the Covid-19 downturn and be strong enough to lend during the recovery. The European Central Bank, which supervises the largest banks in the eurozone, has warned banks could be facing $1.7 trillion in bad loans under an extreme, yet possible, economic scenario.
The proposal for the bad banks announced Wednesday by the European Commission, the EU’s executive arm, underscores its limits in trying to create EU-wide solutions that all member states can agree on. The effort would rely on individual governments to sponsor the bad banks, falling short of more ambitious proposals for a continentwide bad bank.
Banks in the south of Europe, such as Italy, Spain and Greece, tend to see a surge in loan defaults during economic downturns. The issue is less severe in richer northern European countries such as Germany and the Netherlands, which have blamed individual countries and their banks for their troubles.
Bad loans have been a big problem for the bloc since the sovereign-debt crisis in 2011, when banks choked on mountains of defaulted loans, hurting profits and their ability to lend. Banks were still cleaning up their balance sheets when the coronavirus pandemic hit.
Andrea Enria, the head of banking supervision at the ECB, has called for a EU-wide asset manager that could take the bad loans from the banks’ books, freeing up their balance sheets to continue lending. He said the cleanup was too slow in the previous crisis.
More on Europe’s Banks
Such a solution isn’t feasible, the commission said Wednesday, because countries have different nonperforming loan portfolios, different national rules on insolvency, and it would be too costly. Instead, the commission said it would support countries that wish to set up a bad bank.
If enough member states do so, it said, the commission could help to enable a network of national bad banks where they could exchange information on the creditors, debtors and the loan services.
As part of the package, the commission is also trying to develop a secondary market for bad loans and to unify insolvency rules across the continent, both key to helping banks find buyers for their nonperforming assets.
Italy and Spain have sold a chunk of their nonperforming loans to private-equity firms and hedge funds, which are attracted by the very low prices and in many cases the real estate underpinning the loans. While the pandemic slowed the market at first, it has since picked up. Greece, which has the highest level of bad loans—35% of the total at the start of the year—has been a big NPL seller this year.
“Today’s strategy will help contribute to Europe’s swift and sustainable recovery by helping banks to offload these loans from their balance sheets and keep credit flowing,” said Valdis Dombrovskis, a vice president at the commission.
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