As a new vintage of bad debt ripens, supervisors at the European Central Bank (ECB) are walking a tightrope between allowing banks to argue that everything is alright and spurring policymakers in Brussels into action.
But the European Commission’s strategy for dealing with a post-Covid build-up of bad debt, published in mid-December, falls well short of chief ECB supervisor Andrea Enria’s wishful push for an EU bad bank.
The plan did not even include common funding for national bad banks. Its most notable new idea is for a single European data hub on non-performing loans to be built on an existing European DataWarehouse of securitization assets.
Part of the reason for this torpor is the lack of clear indication, so far, that banks need to write off anything like as much as Enria’s warning of potential Covid-19 loan losses of €1.4 trillion. Indeed, partly thanks to Enria’s dividend ban, the sector’s average capital ratio is stronger than it was before the pandemic.
Deferring problems
However, disregarding the gravity of the risks neglects a clearer reality in weaker member states, especially in southern Europe.
Brussels may be turning a blind eye to festering risks in these countries, encouraging them to defer their problems until such time as the economy in the core is back on its feet – even if that means, in a familiar pattern, that the periphery’s crisis goes on for much longer.
Far from seeking publicly backed recapitalizations, big European banks – some bolstered by investment-banking gains – are pushing to return to dividend payments as soon as possible.
But if, over the longer term, lenders have generally sailed through such a big recession with little or no damage to their capital ratios, that is largely because the bigger states have already assumed a large part of their banks’ Covid-19 risks.
Weak banks and borrowers may kid themselves into a false sense of security, as there is no pressure to repay
Outside Germany, it is harder to use state-guaranteed loan programmes to pay off pre-Covid borrowing. Yet across Europe, these programmes have done a similar thing, removing much of the banks’ biggest post-Covid risks, even at a micro-level, because money is fungible.
That has benefited banks in Italy and Spain even more than it has benefited banks in France. State-guaranteed lending for borrowers hit by Covid-19 has surpassed €100 billion in each of these three countries.
The key thing, though, is that state-guaranteed loan programmes are of a far smaller scale, even as a proportion of the economy, in the poorer and weaker southern eurozone countries: Cyprus, Greece and Portugal.
Legally enforced loan moratoria have had to play a bigger part in these countries, instead. Why? Because it places less burden on the sovereign and more on banks, even though their banks were already generally weaker than peers elsewhere in the eurozone.
The fact that France’s loan moratorium expired in September, with almost all the concerned borrowers returning to normal payments, has added to a complacency of European opinion.
France’s situation, however, is no guide. French banks’ costs of risk have long been low by global standards, while the opposite is true of southern Europe.
Italy is also in a better position than it might be, because it is less reliant on external sovereign debt holders and, above all, because it is too big to fail – and knows it.
This is why it was able to offer a far bigger state-guaranteed loan programme than smaller southern European states – and with some credibility, even though its indebtedness is similarly dire.
Spain enjoys some benefits of size, too, although its biggest advantage is slightly lower indebtedness.
Even Italy has placed about €180 billion-worth of past loans in its moratorium, according to Fitch.
Worryingly, the big Italian banks with the higher proportion of loans under this moratorium are the ones that were already weaker: Banca Monte dei Paschi di Siena and Banco BPM, both with about 18%, compared with less than 10% at UniCredit and Intesa Sanpaolo, according to Barclays.
Now, predictably, southern Europe’s weakest countries are extending these moratoria, unlike France, where the moratorium only ever amounted to about 7% of loans, according to Fitch. Germany never really had a moratorium.
Italy’s moratorium, covering about 15% of customer loans, will now run until June – as will Cyprus’s, which amounts to more than half the entire stock. Portugal’s moratorium, which affects a quarter of the book, will run until September. Greece is also, in various ways, delaying a return to normal repayments for borrowers subject to its moratorium, which affects about 17% of loans.
The result is that banks in these countries won’t report the real impact of the crisis on their borrowers until late 2021, at the earliest – not until 2022 in Portugal. Further extensions will come as no surprise.
In the meantime, weak banks and borrowers may kid themselves into a false sense of security, as there is no pressure to repay. On a macro-level, everyone will be left guessing, fearing the worse.
This comes at a time, moreover, when northern European governments, especially the UK, are turning to border controls to fight Covid because of fears of new strains of the disease and to protect progress on vaccination.
This could mean an even worse summer for foreign tourism, removing what was the weaker Mediterranean countries’ main source of growth.
Meanwhile, they won’t even be able to begin spending cash from the EU’s €750 billion recovery fund until mid 2021.
Stronger tools
All this means that banks in countries such as Greece and Portugal, and a lesser extent Italy, urgently need stronger tools to bolster their balance sheets, such as via an EU bad bank.
Southern European banks’ interest margins are suffering almost as much as their northern peers from negative ECB rates, but it is less of a problem for northerners because they’re less in need capital from retained profits to fund loan write-offs.
An EU bad bank would be better than a loose network of nationally funded domestic bad banks, which will put even more burden on already-weak sovereigns.
Wobbly lenders, argues University of Amsterdam professor Arnoud Boot, won’t be able to offload assets onto the bad bank unless the price is sufficiently favourable and below fair value.
Alas, that is also why the EU bad bank won’t happen, as northern politicians would worry about a transfer of public wealth.
A more standardized EU framework for bad banks, even national ones, is better than ignoring the risks, which is what is happening now.
However, as Boot and others argue in a recent Leibniz Institute paper, national bad banks, as opposed to an EU one, will emphasise national interests and weaknesses, undermining the EU’s still-incipient banking union.
This will do little to loosen the bank-sovereign doom loop and will make future eurozone blow-ups more likely.
Note, indeed, that the latest wave of European bank M&A has so far been purely domestic. In effect, the banks’ solution to Covid-19 has already been to build a sector based more on national champions rather than pooled risks.
The recent battle for UniCredit – with a more pro-European French CEO pushed out in favour, ultimately, of an Italian – is particularly telling in this context.
In this crisis, at least in banking, it seems the instinct to protect those around you is coming to the fore once again in Europe.
