A pan-European bad bank

The NPL burden

The burden of non-performing loans (“NPL”) in the balance sheets of European banks is enormous. According to the European Banking Authority („EBA“) European banks hold NPL with an aggregate nominal of more than one trillion EUR. Ten European countries have an NPL-ratio of more than 10% which is four times the ratio of Germany (2.6%). On average the NPL-ratio of the European banks is 5.4%, far too much to speak of a healthy banking environment. It is feared that the high proportion of NPL will not only limit the loan originations of banks but, as a consequence, also paralyse large parts of the European economy.

Recent regulatory changes like the increase of own funds requirements or the “Single Resolution Mechanism” certainly have a risk minimising effect on the banks and on tax payer’s money, but they do not foster bank lending to the real economy. The Capital Markets Union initiative, on the other hand, does indeed focus on supporting the financing of the real economy and contains some good ideas and approaches. But most of its concrete actions will not produce short term results and are, by and large, still in the planning phase.

The missing tool

Hence, according to some influential voices in Europe, an effective tool is missing to lower the NPL-ratio significantly in the short run and in this way fight long-term paralysing effects for the European economy. Andrea Enria, current chairman of the EBA, triggered the discussion in a speech in Brussels at the beginning of the year, where he demanded a pan-European bad bank in the form of a so called Asset Management Company („AMC“). The Head of the European Stability Mechanism (“ESM”), Klaus Regling, principally agreed and Vítor Constâncio, Vice President of the ECB also promotes the idea.

The proposed solution

The core feature of the proposal is that the European AMC buys NPL from the banks at their economic value which is determined based on a long term perspective. Effects that typically depress market prices (like liquidity aspects, supply surplus, uncertainty) can be reduced in this way. Nevertheless this can already cause the need for write-offs in the banks in case the economic value is lower than the book value. In extreme cases, this may also lead to the necessity of restructuring or support measures. Having received the NPL, the AMC shall have a clearly defined time span (e.g. three years) within which it must sell the assets with the aim of realising the economic value that the AMC paid for it. Should the AMC not succeed in realising such value, the bank and its member state respectively must bear the losses. In order to be able to assess the likelihood of such an effect beforehand a stress test is envisaged as the very first step of the transaction. Concrete details are not known yet. But it is probable that the AMC would need to be secured for such case by a guarantee from the member state of the bank’s registered office.

Also the initiators point out that a state support solution is only second best and not desirable in the long run. In their view private sector approaches are much more preferable, in particular to be included right from the start and strengthened step by step. Mentioned are clearing houses to optimise information distribution, i.e. improve transparency, and securitisations to fine tune risks. The private sector alone however is not yet ready to cope with this problem, according to the initiators, so that the AMC appears to be the only way to accomplish positive effects in the short and medium term.

The basic idea of such a pan-European bad bank certainly offers advantages worth discussing. It would establish consistent standards across Europe and create synergy effects. Also, in a sense, it would generate pressure to effectively tackle the NPL problem in all member states.

Hurdels to be overcome

But, in order to realise such a model, several hurdles need to be overcome. European subsidy law and the bank recovery and resolution rules will have to be complied with. At the same time some member states must be convinced that it is wise to realise looming losses immediately without the certainty that this will be all, other member states must be convinced that no transfer-union effect will take place, i.e. losses will not be born for banks of other member states. For the latter guarantees of each member state for the NPL of its banks could be implemented. Of course this may raise the question of how much such guarantee will be worth in certain cases. So the proposal already contains a “plan b” option if “plan a” should not be acceptable. According to plan b, as a minimum requirement, all member states should follow the same set of standards if, instead of one AMC, several national AMC should need to be established (“blue-print”). An open question is how the banks are to recognise the possibility of having to carry an additional loss after the three years. A big hurdle, which understandably is not being emphasised too much in speeches that mean to present the big picture of a solution, is the old familiar “devil in the detail”. It would constitute a mammoth task to administer and liquidate tens of thousands of loans of various asset classes, from 20 different jurisdictions and different language Areas in one entity and to do so in an optimised and value-maximising way.

So, there are many open questions. But it is important that they are being asked. We should take the proposal as an impulse to have this crucial discussion!

Your contacts

Philipp von Websky
pvonwebsky@deloitte.de
+49 211 8772 3867

Andrea Weber
andweber@deloitte.de
+49 211 8772 4769