Even without the coronavirus crisis, it would have been difficult to set up a bad bank in the eurozone. Now that countries are putting different moratorium measures in place in response to the pandemic, it is next to impossible.
The demands for a European bad bank – like those for EU-wide government bonds – are not new. Both ideas have been circulating since the European sovereign debt crisis nearly a decade ago and gained particular prominence in the middle of the last decade after non-performing loans (NPL) remained high in rescued countries like Cyprus, Greece and Portugal.
But in 2018, when Portugal and Cyprus had developed their own NPL markets – the sale of debt mainly through private bad debt securitizations or portfolio sales – the claims for a European distressed bank had died. Markets had developed independently of the efforts of the European Central Bank, and countries like Greece noticed the success of the Italian NPL securitization system (GACS) and set out to develop their own.
Then the pandemic struck and calls for mutual debt rose again. It has become clear that Europe needs to start all over again to prepare for a new generation of sour, defaulted loans that pile on the remnants of the 2008-2012 trash can ends.
This would have been a Herculean task before the coronavirus crisis, but thanks to countries that have gone their own way on pandemic packages, there are now two problems.
The first concerns harmonization. There has to be a common standard for a block-wide solution to work, but countries have very different debt problems. Without a harmonized fiscal policy, the EU institutions will have to cut their work in order to shift debt internationally, as outlined in GlobalCapitalon Monday.
The second and more immediate problem is simply classification – how do you recognize a bad loan? This was made more difficult by the fact that no harmonized strategy for granting credit moratoriums was adopted across Europe.
In the Netherlands, for example, borrowers are not required to show that they are financially affected before imposing a mortgage moratorium, while most UK banks, for example, require their customers to do so.
For a servicer, how do you distinguish between loans that a borrower has not paid voluntarily and those that have been given to a borrower who has imposed a moratorium? Based on recent bank earnings reports, individual lenders have not even created a category for such loans, let alone a harmonized approach to getting them back into payment.
Satisfying everyone in this case would mean not pleasing anyone, as the only acceptable compromise would be to follow the lowest common denominator, an approach that would hamper recovery in the rest of the euro area.
The idea of a bad bank in the entire euro zone is little more than another move by those who want to harmonize EU debt and debt consolidation. However, the burden of NPL divestments on international institutions would mean undoing the years of work put into setting up national systems.
Instead, the EU institutions should focus on easing state aid rules, abandoning non-performing 2020 exposure targets and providing banks with more guidance on consolidating loans that have been granted moratoriums.
With the support of the European Central Bank and the European Banking Authority, temporary solutions could be agreed where NPL systems would be implemented at national level by buying acidic loans from bank balance sheets and either buying back the assets to the banks once the loans are canceled according to a set one Period or disposition of the loans in a traditional portfolio sale if the loans have not recovered.
NPL systems at the national level have been shown to be effective in reducing the volume of NPLs. With a little more leeway, EU Member States could do more on their own than they already have without waiting for a cumbersome giant to come out of Brussels to do the same job for them.