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Pan-EU 'bad bank' proposal fraught with challenges

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Pan-EU 'bad bank' proposal fraught with challenges

A pan-European "bad bank" could help reduce the continent's stubbornly high levels of soured loans, but setting it up would be extremely difficult, experts say.

The head of the European Banking Authority, Andrea Enria, has called for the establishment of an EU-wide asset management company, or AMC, to help resolve the €1 trillion of nonperforming loans that are still sitting on banks' balance sheets — the legacy of precrisis loose lending standards, mismanagement and sluggish economic growth.

In a Jan. 30 speech, Enria said the AMC would buy loans at an assessed price rather than a market price, and would then have three years to sell them on at that assessed price. If it could not, the transferring bank would have to take the full market price hit.

Previous attempts at a market-based solution to the NPL problem have foundered due to a lack of comparable data and a lack of potential buyers, according to the EBA, which serves as a banking watchdog to the EU.

The move would send a "strong signal" to investors that Europe is serious about tackling bad loans, Eleni Panagiotarea, research fellow at the Hellenic Foundation for European and Foreign Policy, said in an interview.

"In Italy, Portugal, Greece and Slovenia, it could really help with resolution of NPLs, which would enable the banking sector to lend to the real economy," she said. As of June 2016, problem loans totaled €276.0 billion in Italy, €40.8 billion in Portugal, €115.1 billion in Greece and €3.3 billion in Slovenia.

Troubled lenders would inevitably have to take a loss in the process of transferring assets to such an entity, David Edmonds, global head of portfolio lead advisory services at Deloitte, said in an interview. But an AMC would probably be able to pay them a higher price than other market participants because it would have access to cheap, government-backed funding. The EBA has said it would be partially taxpayer-funded.

A Herculean task

However, creating a cross-regional entity to deal with a broad mix of asset classes would be an unprecedented task.

"There are a lot of pros to a pan-European bad bank, but the devil is in the detail," Edmonds said. Those that have existed have been institutional or country-specific, but not pan-regional, he said.

Other troubled asset management entities, such as Ireland's NAMA, created in 2009 to work out €77 billion of toxic assets, and Spain's SAREB, set up in 2012, have focused on single jurisdictions. Both were primarily concerned with soured loans connected to commercial and residential property following the 2008/2009 market crash.

The proposed AMC might be a workable solution for specific pockets of assets that banks are struggling to manage or sell, or instances where a single borrower with loans from multiple lenders has defaulted, but not for the full €1 trillion load of NPLs, Edmonds said.

Cross-regional challenges

Panagiotarea said putting it into practice would be tough.

"A bad bank involves choices — about the type of assets to be transferred, the valuation framework and [the] portfolio strategy," she said. "Who is going to make those choices in a manner that is fair and equitable?"

Dealing with the range of different frameworks relating to banking law and insolvency in various European countries would be a huge challenge.

"Would a country with a weak institutional framework like Greece be on the same level playing field as a country with a strong institutional framework?" she said. "Who would guarantee it?"

A bad bank could also be "politically unappetizing," throwing up questions around moral hazard if taxpayers help to fund the plan, she said.

Paul Lewis, head of loan advisory at CBRE Loan Services, pointed out that provisioning levels for NPLs vary widely from country to country.

"That would have to be dealt with," he said in an interview. "The transfer of loans will be challenging. The Italian NPL position is very different from the Irish position, for example."

The EBA does not have the power to create a bad bank on its own. A spokesman for the watchdog said in an email that Enria's proposal was "aimed at stirring the debate at EU level on the need to act fast to address this issue."