Published June 2017

How big a problem are non-performing loans in EU-banks?


The amount of non-performing loans in the EU banking system is estimated to be about € 1.06 tr representing 5.1% of total gross loans and covered at 44% by provisions. EU banks have lowered NPL ratio from the peak of 6.8% reached in 2013. The European regulators have so far pushed banks to replenish their capital which they successfully achieved.

Now comes the time to handle the economic growth which has been subdued. One of the solutions could come from the reduction in NPLs as financial institutions could grow their lending volumes once their balance sheets are alleviated of these.


The magnitude and duration of EU non-performing loan (NPL) overhang remains a significant challenge. This remains at historically high levels both in the aggregate and as a percentage of EU 19 GDP. The structure and composition of the Euro 19 economies depend upon bank lending to spur growth that requires cleaner bank balance sheets.

There has been no meaningful reduction of gross NPLs in most jurisdictions. Short of a continuance of ECB funding programs together with quantitative easing, many jurisdictions could face funding challenges. The balance sheet of the ECB has increased significantly and will eventually need to wind down.


After peaking in 2013 at 8%, the NPL ratio has come down to around 5%. This is a significant issue for Europe as the approximately €1tn of bad loans represents nearly 9% of Euro Area GDP. NPLs are problematic from a macro-perspective because they impact bank profitability which drags down economic growth through preventing new lending and locking up bank capital.

Asymmetric information is causing huge bid-ask-spreads which are stopping the NPL market from clearing. Until a solution such as a European ‘bad-bank’ is agreed, credit supply and ultimately economic growth will be constrained.

Non Performing Loans (NPLs), along with weak profitability, are the two major remaining challenges facing the European banking sector in our view. Evolving monetary policy changes should help the latter, but more work may be required to improve the former. Impaired assets act as a drag on earnings as the loans still have to be funded and they consume a lot of bank capital (in the form of higher Risk Weighted Assets).

Management time and resources can be taken up by these legacy issues, to the detriment of more value enhancing activities. As a result lending to the real economy can suffer in countries with high NPL rates.


It is a concern and a top regulatory priority. With the last stress test, the European Banking Authority harmonized the definition of NPLs to get a clearer picture of the problem and asked banks with above average NPLs to submit reduction plans. Together with stronger economic growth, the EU-wide average is now below 6 percent.

The NPL problem negatively affects profitability (non-interest earning assets, higher loan loss provisions, operating expenses for workouts, potentially higher funding costs), capital (higher risk weights) and credit ratings as asset quality is an important factor in these assessments. We expect NPLs to continue trending down.



In which countries is the problem most severe?


Apart from Greece and Cyprus where the NPL ratio are above 45%, Italy is actually where the NPL level is the most dramatic. German banks’ NPL ratio was only 2.5% and their main shareholders, the German regions, are likely to continue to recapitalize their banks and to overcome BRRD rules.


Most severe: Italy, Spain, Greece, Portugal, and Cyprus versus Germany, France, and the Netherlands. Ireland has the most progress with GDP rising. German NPLs largely concentrated in shipping loans impact a handful of mostly Landesbanks. The issue is typically around appropriate German coverage levels versus NPL recognition at this stage.


In Cyprus, Greece, Italy, Ireland, Portugal and Slovenia the average 2016 NPL ratio was 22.8% compared with 4.8% in 2007. In contrast, for 2016 NPLs were 1.5% in US and 1.0% in UK (0.1% higher than 2007). Most of these poor performing countries have had comprehensive banking sector restructuring.


The problem is most severe in the periphery and Cyprus which make up the majority of Europe’s NPLs (of +€1 trillion). Most of these exposures relate to legacy problems from the last downturn. However certain segments are still deteriorating, with shipping exposures currently a particular concern for German banks.


Problem countries include Italy (low economic growth, unfavorable bankruptcy law for old NPLs), Spain (suffering from real estate bubble but trending down), Ireland (high levels from real estate bubble issues but helped by strong economic growth and rising house prices) and Portugal. A few German banks have significant shipping exposure.



How can the problem (if any) be solved?


An EU bad bank would enable Italian banks to solve the legacy issue of NPL in the context of BRRD. However Germany does not back such a project. Another solution could be to suspend BRRD rules to allow Italy to set up a national bad bank as Ireland and Spain did.


 “Bail-in” and EU restrictions upon “State-Aid” limit “good bank/bad bank” solutions. NPL sales have helped but not to a significant degree. National solutions are more likely given the high hurdles tapping the ESM in addition to political resistance. Best case: finalization of a unified chart of accounts for EU banks.
Setting up a European ‘bad-bank’ to buy NPLs and close the gap between the economic value of the loans and the market price would enable banks to clean balance sheets leaving them to concentrate on driving productive growth. However low ROEs are also a result of high costs and overbanking.


We believe it’s possible, but the challenge is around designing the vehicle in such a way that it doesn’t expose large capital shortfalls at the time of asset transfers. As this would require burden sharing (under EU State Aid rules) with equity and debt holders if public intervention is required.


An EU bank for NPLs will face difficulties due to the bail-in directive and implementation disagreements. Further improvements can be achieved by tighter European-wide bankruptcy laws that shorten the foreclosure process. This will help further develop a functioning secondary market for NPL sales including securitizations.


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