Andrea Enria, head of the European Banking Authority warned in an interview with Handelsblatt that addressing non-performing loans is becoming urgent. German central bank and finance ministry officials fear the country would pay yet again for the financial mistakes of other countries.
Handelsblatt: You’ve proposed an E.U. wide asset manager to deal with the €1 trillion burden of non-performing loans on the balance sheets of European banks. Why would we need such a bad bank?
Andrea Enria: We have more than €1 trillion of non-performing loans in the European Union. They represent 5.4 percent of total loans, a ratio three times higher than in other major regions of the world. The International Monetary Fund (IMF) has come to the conclusion that a ratio between 5 and 6 percent is starting to have a serious negative impact on the ability of banks to lend and to support the economy. The good news is, that the ratio is coming down, but the decrease is extremely slow. In the 1990s Japan took more than 15 years to deal with its problem loans, with major detriment for its macroeconomic performance. If we continue at this pace, we will take longer than Japan to complete the adjustment and reach pre-crisis levels. There is an urgent need for policy action.
But is there really a need for an E.U. wide initiative? Bad loans are mainly concentrated in some of the southern and eastern countries. Wouldn’t a system of national asset managers achieve the same goals?
You are right, the non-performing loans are not evenly distributed among E.U. countries. But there are 10 countries with a ratio of non-performing loans above 10 percent. At a minimum, it would be important to define common European blueprints for national asset management companies. This would help clarifying the criteria for the application of the E.U. rules on crisis management and state aid and developing a common framework for the dissemination of information. However, with an E.U. wide initiative, it would be much easier to achieve critical mass and to create a well functioning secondary market for those asset. My fear is that if we were to rely only on national action, there might be resistance to take the bold measures that are needed. The problem is really clogging the functioning of bank financing for the euro area as a whole, which also means that the transmission mechanism of monetary policy is not working as effectively as it should.
How would your proposal work in detail?
A stress test would define the maximum losses under adverse conditions, thus determining the potential need for state intervention. Then the banks would sell their non-performing loans to the asset management company at a price reflecting the real economic value of the loans, which is likely to be below the book value, but above the market price currently prevailing in illiquid markets. So the banks will likely have to take additional losses. The asset manager would then have three years to sell those assets to private investors. There would be a guarantee from the member state of each bank transferring assets to the asset management company, underpinned by warrants on each bank’s equity. This would protect the asset management company from future losses if the final sale price is below the initial transfer price. In case the guarantee is activated, the warrant would ensure an appropriate dilution of existing shareholders.