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ECB: Intervention without dread

The European Central Bank must take action, but with nuance, in its new regulatory framework for non-performing loans.

ECB draghi-600

The ECB's president Mario Draghi

Draft ECB guidance on non-performing loans serves again to fan fears over how the single supervisor’s methods might affect the solvency of some of Europe’s weakest banks. Banks are required to step up efforts to organise and gather data on bad debt, it says. They must have a coherent strategy for reducing these loans, with dedicated and adequately staffed NPL workout units.

The core of the guidance, as research from Deutsche Bank points out, is the timeliness of action to tackle bad debt, in particular at banks with the worst NPL ratios. “The ‘wait and see’ approach, too often observed in the past, has not solved the issue,” it says. The guidance calls for banks with relatively poor asset quality to adopt “realistic and ambitious” targets for reducing bad debts.

But let’s not forget that the zombification of southern European capitalism, particularly in its backbone of small and medium-sized enterprises, has happened under the ECB’s gaze. Unlike the 1990s emerging markets crisis, there was no drastic devaluation of national currencies to force weaker businesses into bankruptcy: or to make it easier for better firms (generally those with higher export earnings) to pay local borrowing, while their exports became more competitive. Now rock-bottom interest rates swell the zombies’ ranks and prolong their misery.

Painfully aware

The ECB must be painfully aware of this. As it tries to infuse the periphery with a new lease of life, it must be careful of deploying blunt tools to force a rapid reduction in bad debts, as the performance of European bank stocks in recent months has made clear. Its target earlier this year for Monte dei Paschi di Siena to reduce its net NPL portfolio by €10 billion in two years has not yet solved the fundamental issue of the gap between the book and market value of these debts. Instead, it could open wide financial and political cracks in Italy, and beyond.

Banks will inevitably struggle to discount their bad-debt portfolios for the kind of return that private-equity buyers seek. Putting more pressure on them to sell these loans quickly will depress their prices and bargaining power even further, fuelling market volatility that will make it even harder for banks to fund write-offs through rights issues. It could already be harming Portugal’s perceived sovereign creditworthiness.

Italy’s Banco Popolare and Spain’s Banco Popular have already issued several billion euros of public equity this year, in large part to fund NPL write-offs: actions behind which the ECB lurks. The biggest banks in Portugal and probably Italy will now be making similar requests, and MPS’s plan to offload bad debts in a €28 billion securitization is a precursor for a multi-billion-euro capital raising.

What should be the focus of the ECB’s NPL push is the creation of a more active secondary market in peripheral NPLs, especially those for SMEs. Perhaps that might mean in some cases banks might be allowed to make less provision, for example, for real-estate developments, which have less need for working capital and are less important for the economy. Above all, the ECB’s efforts must focus on the NPL market infrastructure, such as helping develop judicial backing, and banks’ own capacity to prepare for debt sales.

This NPL problem goes to the heart of the eurozone’s malaise. The ECB should make up for the lack of a forced exchange-rate rebalancing in the periphery. But the union is at its best when it offers institutional support; it is at its worst when it hands out vindictive diktats. If the periphery is to benefit from the euro, Brussels and Frankfurt cannot push their banks and economies from stagnation to Greek-style destruction. The regulators need to pick their battles wisely.

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