Andrea Enria, head of the European Banking Authority warned in an interview with Handelsblatt that addressing non-performing loans is becoming urgent. German central bank and finance ministry officials fear the country would pay yet again for the financial mistakes of other countries.
Handelsblatt: You’ve proposed an E.U. wide asset manager to deal with the €1 trillion burden of non-performing loans on the balance sheets of European banks. Why would we need such a bad bank?
Andrea Enria: We have more than €1 trillion of non-performing loans in the European Union. They represent 5.4 percent of total loans, a ratio three times higher than in other major regions of the world. The International Monetary Fund (IMF) has come to the conclusion that a ratio between 5 and 6 percent is starting to have a serious negative impact on the ability of banks to lend and to support the economy. The good news is, that the ratio is coming down, but the decrease is extremely slow. In the 1990s Japan took more than 15 years to deal with its problem loans, with major detriment for its macroeconomic performance. If we continue at this pace, we will take longer than Japan to complete the adjustment and reach pre-crisis levels. There is an urgent need for policy action.
But is there really a need for an E.U. wide initiative? Bad loans are mainly concentrated in some of the southern and eastern countries. Wouldn’t a system of national asset managers achieve the same goals?
You are right, the non-performing loans are not evenly distributed among E.U. countries. But there are 10 countries with a ratio of non-performing loans above 10 percent. At a minimum, it would be important to define common European blueprints for national asset management companies. This would help clarifying the criteria for the application of the E.U. rules on crisis management and state aid and developing a common framework for the dissemination of information. However, with an E.U. wide initiative, it would be much easier to achieve critical mass and to create a well functioning secondary market for those asset. My fear is that if we were to rely only on national action, there might be resistance to take the bold measures that are needed. The problem is really clogging the functioning of bank financing for the euro area as a whole, which also means that the transmission mechanism of monetary policy is not working as effectively as it should.
How would your proposal work in detail?
A stress test would define the maximum losses under adverse conditions, thus determining the potential need for state intervention. Then the banks would sell their non-performing loans to the asset management company at a price reflecting the real economic value of the loans, which is likely to be below the book value, but above the market price currently prevailing in illiquid markets. So the banks will likely have to take additional losses. The asset manager would then have three years to sell those assets to private investors. There would be a guarantee from the member state of each bank transferring assets to the asset management company, underpinned by warrants on each bank's equity. This would protect the asset management company from future losses if the final sale price is below the initial transfer price. In case the guarantee is activated, the warrant would ensure an appropriate dilution of existing shareholders.
If member states were to intervene to facilitate the process, would this state aid be granted according to the new E.U. rules for bank recovery and resolution?
Absolutely, the proposal is based on the full application of all existing rules for bank recovery and resolution and also the rules for state aid by the European Commission.
Which would mean that not only the banks would have to take losses, but also shareholders and bond holders. If that were to happen in several E.U. countries at the same time, wouldn’t that undermine the trust in the whole system?
If the establishment of an asset management company helps creating a well functioning secondary market, and the assets would be sold at a more reasonable price, then I wouldn’t see this danger. In any case, most banks have already strengthened their balance sheets sufficiently to be able to absorb additional losses. If the dismissal of non-performing loans generates additional losses, banks will have to accept it and move on. If they fail to take action these losses won’t disappear, they will just come back later to haunt them.
Could the proposed asset manager really work without any form of burden sharing or guarantees from all the member states?
I know that this is a very critical point especially in Germany. The whole structure is designed to avoid any form of mutualization of losses or sharing of risks. Any state aid that might be necessary would be addressed exclusively at the national level. The European dimension is only intended to ensure that action is taken now, by all banks with asset quality problems, according to common rules and procedures.
You already emphasized, that the whole process would work according to the banking recovery and resolution rules. But do these rules really work in practice? Didn’t the case of Monte dei Paschi di Siena prove that it’s hardly possible to bail out shareholders and bond investors without causing political turmoil and undermining the trust in the whole banking system?
Thanks to the European Commission and its framework for state aid control, the principles underlying those rules, which have been created to minimize the burden for tax payers, have already been applied in a number of countries before the implementation of the recovery and resolution regime. Examples include Cyprus, Greece, Spain, Portugal, Italy, Slovenia, Austria, the Netherlands and Denmark. Now that the rules are fully in place, we need to make sure that they are effectively and consistently applied across the European Union.
What would be the time frame to implement your proposal?
The sooner the better, especially since the market needs certainty. So I hope that we reach a conclusion at the European level in the spring.
Financial regulation has become a highly political topic since Donald Trump has signed an executive order to review the so called Dodd-Frank Act, which is the main instrument for the U.S. to implement the lessons from the financial crisis. Is this the beginning of the end of global consensus in financial regulation?
We have to suspend judgment and see precisely which changes will be implemented in the rule book in the United States. In my opinion, international standards should be respected. If there are deviations from these standards, that would be a cause of concern. The lesson from the crisis is, that any process of deregulation in a single country poses the danger of exporting risks to other countries and into the global system.
That sounds as if you were afraid of a race to the bottom in financial regulation.
That’s exactly what international standards are supposed to prevent. Regulators have to trust one another to allow banks to operate on a cross border basis.
In the Basel process for creating new international standards for bank regulation, there’s already strong disagreement between the United States and the Europeans. Do you think a compromise is still possible?
There have been difficult discussions in the Basel process, but we have also made a lot of progress and have come close to an agreement. In my view there is not much distance left anymore between the different positions, and I would be disappointed if we wouldn’t be able to reach an agreement in a reasonable time frame, also because the banks need certainty and we have to complete the regulatory reform process.
Michael Maisch is the deputy chief of Handelsblatt's finance desk and based in Frankfurt, Germany's financial capital. To contact: [email protected]