The European Commission's proposals to speed up the reduction of new bad loans by EU banks will help eliminate the legacy of the financial crisis for the region's banking sector and will prevent banks from having to make large provisions for existing loans, according to market participants.
On March 14, the Commission set out a series of measures that would require lenders to put aside more funds to cover the risk of new loans going sour and encourage them to reduce their existing books of nonperforming loans. European banks, especially in Greece, Cyprus, Portugal and Italy, have been saddled with bad loans since the financial and sovereign debt crises, and the proposals are designed to reduce risk and increase lending.
"The goal is simple — to speed up the ongoing reductions of NPLs in Europe's banks and prevent them from building up again in the future," Valdis Dombrovskis, the EU commissioner for financial stability, financial services and the capital markets union, said at a news conference in Brussels. "This will free up [the] capacity of banks' balance sheets and allow them to expand lending to businesses and households."
Under the proposals, banks would be subject to a minimum coverage level for newly originated loans that become nonperforming. If they are not able to meet this level, they will face deductions from their own funds. EU states and the European Parliament need to approve the proposals to make them law.
Banks had feared the proposals might apply to existing loans, which would have resulted in a sharp rise in provisions for some lenders, especially in countries like Greece and Italy.
"Many people are focusing on the provision requirements, but these only apply to new loans, so they should not affect the stock of NPLs of Italian banks. A retroactive application would have been more problematic in the near term," Marco Troiano, a banks analyst at Scope Ratings, said in an email.
"Little should change when it comes to dealing with the legacy of the great financial and sovereign crisis, and not much is needed — things are already improving organically," he said.
One-size-fits-all not appropriate
Some say a one-stop approach to loan provisioning in a diversified European banking sector is not appropriate, and the Association for Financial Markets in Europe said in a statement that potential shortcomings in provisioning should be addressed on a bank-by-bank basis.
"Blunt, one-size-fits-all ... prudential backstops are unnecessary," AFME Chief Executive Simon Lewis said in a statement.
Banks will have eight years to fully cover potential losses for secured loans — one year longer than a proposal from the European Central Bank — with coverage increasing gradually from minimum 5% coverage in the first year to 75% by the seventh year. They will have two years to fully cover potential losses from unsecured new loans.
The ECB is scheduled to present its plans for reducing nonperforming loans among eurozone banks, and European Banking Federation spokesman Raymond Frenken said the banking sector was "eagerly" looking for clarification on the timeline and treatment of loans.
On the whole, the sector is beginning to turn the page on the crisis, Frenken said. "Banks are in a completely different and better shape than they were 10 years ago."
Dombrovskis said the Commission was focused on regulatory measures to help the banking sector, while the ECB was implementing supervisory measures.
Funding cost reduction
The proposals will give certain secured creditors the ability to seize the collateral underpinning a loan without going to court. This out-of-court enforcement will be limited to loans granted to businesses and will exclude consumer loans, and will only apply when the business in question has agreed to it. This will allow banks to reduce funding costs by 10 to 18 basis points, especially in countries where the bad loan recovery is slow, Dombrovskis said, and by up to 40% for small- and medium-sized businesses.
The same directive will remove barriers to credit servicing and to the transfer of loans to third parties around the EU, which will help develop secondary markets for NPLs. Among other things, the proposal defines the activities of "credit servicers," which are contracted to manage portfolios of loans and collect debt, and sets common standards across the EU. The development of a secondary market would reduce NPL sales by up to 15% a year, Dombrovskis said.
"It could help smaller countries in particular, by allowing more [credit] servicers to compete for business in a country that they may not have otherwise entered, such as Greece and Cyprus, " DBRS analysts said in emailed comments. "It should also help countries where the judicial process can be an impediment to a rapid resolution of bad loans, such as Italy."
They also said the proposals should increase the prices that secondary-market buyers would be willing to pay for portfolios and increase the chance of a sale, while giving banks more opportunity to recover the funds.
