The European Central Bank (ECB) will seek to address Europe’s €900bn Non-Performing-Loans challenge (NPLs) one bank at the time.

One bank at the time

Europe’s banks have an NPL portfolio that is equivalent to 6-to-7% of the  EU’s entire GDP, that is, treble the burden carried by lenders in the United States and Japan.

And there is another difference between the US/Japanese and European banking sectors. The EU does not have either a consolidated financial market or a single banking supervisory authority. Lenders face different challenges, diverse economies, market rules and conditions. More than 10 EU member states have non-performing loans in excess of 10% of their investment assets. Among the 28, the range of NPL’s varies from 1% to 46% of the total asset portfolio.

On Tuesday, the President of the ECB Mario Draghi noted that major EU lenders reduced the share of their NPL portfolio from 7,5% to 5,5%. However, Draghi warned, there is no room for complacency as addressing the challenge of NPLs is a precondition for the banking union.

The supervisory chief of the ECB, Daniele Nouy, attempted to address criticism against proposed blanket regulation that in effect outlaws NPLs. In October, the ECB asked banks to secure themselves against the risk of NPLs by 100%, beginning from January 1st, 2018.

Systemic Risks & Case-by-Case solutions

That rule is particularly burdensome for countries with a sizable NPL portfolio. One in four non-performing loans in the EU is Italian. In Greece and Cyprus NPLs exceed 40% of lenders portfolio. In these countries, being forced to bolster banking reserves could force banks to disrupt the supply of liquidity to the market, threatening a fragile economic recovery.

Addressing this criticism, the ECB clarified on Tuesday that this regulation will not have retrospective effect, with Nouy suggesting that for so-called “legacy NPLs” the ECB would seek case-by-case solutions.

Since January, the chairman of the European Banking Authority (EBA), Andrea Enria, has made a case for a European “bad bank,” which in his view is an answer that addresses head-on Europe’s “urgent and actionable” challenge. In May, this view was echoed by the head of the European Stability Mechanism, Klaus Regling.

But, there is resistance to any notion of a pan-European bad bank, not least because it would constitute a form of debt mutualization, a principle that primarily Germany but also the Netherlands vehemently oppose. In the meantime, the Single Supervisory Mechanism (SSM) has been accused of double standards in the monitoring of Deutsche Bank (DB), compared to Italian lenders such as Monte de’ Paschi di Siena.