European banks need to prepare their balance sheets for the risk of pandemic-induced non-performing loans hitting them in the new year, the head of the EU agency tasked with winding down failing lenders has said. 

Elke König, chair of the Single Resolution Board, rejected suggestions from the European Central Bank that the EU needs to set up a network of “bad banks” to handle higher non-performing loans (NPLs), but she warned banks needed to do intensive work to sort out viable loans from unviable ones. 

In an interview with the Financial Times she also urged the EU to properly harmonise its state aid rules for handling embattled banks with its “resolution” regime, which intervenes to ward off systemic financial crises. Ms König argued that as things stand there was a “misalignment” in the system. 

The SRB was set up following the eurozone sovereign debt crisis to wind down stricken banks while securing financial stability and consistent treatment of the region’s lenders. But with regulators now weighing the risks of a surge in NPLs, the agency is still working with an incomplete system of EU bank-crisis rules which must operate over a patchwork of different national arrangements. 

Last month, the ECB’s top bank supervisor Andrea Enria wrote in the FT that, in a “severe but plausible” scenario, non-performing loans at eurozone banks could reach €1.4tn, well above the levels of the 2008 financial crisis and the ensuing EU sovereign debt crisis.

Ms König said it was too soon to know how bad the situation with NPLs would get, because this would depend on the nature of the downturn and recovery. Current actions by governments, such as state guarantee schemes, were “shielding” the lenders, she added.

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In June 2017, the Single Resolution Board transferred all shares of Spain’s Banco Popular to Santander © Angel Navarrete/Bloomberg

But she said that non-performing loans could start coming through in the first and second quarters of next year. In light of this, her message to banks was “be aware NPLs are coming and the best thing to do is address them early . . . That is the best thing we can do for the time being, and then it is steering through the fog.” 

The European Commission will next month set out its own proposals for handling what Valdis Dombrovskis, executive vice-president overseeing economic policy, has said will be a “likely rise” in NPLs. These include further developing secondary markets in which NPLs are bought and sold, and reforms to insolvency and debt-recovery frameworks. 

The ECB’s Mr Enria has separately advocated the creation of either a European “asset management company”, or a network of them, to take on NPLs. Ms König said that she was cautioning against this idea, and that banks doing their “homework” was the easier way forward. 

“The entire debate . . . always lacks one component: who is footing the bill,” she said. Ms König added that “it feels sometimes as if this is the magic system,” one where losses are supposed to evaporate, something “that is not going to happen”.

Banks need to “get the full transparency” of these portfolios, she said. “They need to be able to separate a portfolio and to set out how they would like to service it, what would be their idea, how would they deal with it.”

She added that in the current crisis there was still a market for bad real estate and corporate loans. When it comes to loans to small and medium-sized enterprises and retail customers, these are traditionally “professionally managed by a bank as an ongoing relationship”.

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Ms König underlined the extensive work that has been done since the dark days of the eurozone crisis to strengthen the resilience of banks, and to ensure that they can be safely wound down if they fail. This work has included making sure money can be raised by wiping out bank bondholders, so shielding taxpayers from footing the bill.

She noted that one of the tools available to her agency was an “asset separation” power to strip bad loans out of broken banks’ balance sheets.

But she emphasised that the EU system for handling failing banks was still a work in progress. One step she has called for is the creation of a “pre-liquidation tool” allowing her agency to intervene earlier in a crisis to save the good part of a bank, preventing needless destruction of value.

The SRB and the broader system it oversees has been fully up and running since 2016, and in that time has handled one bank failure: Spain’s Banco Popular.

One ongoing problem, she said, was that the conditions attached to banks put through national insolvency proceedings differed from those attached to interventions by her agency. This issue flared up in 2017 when two regional Italian banks received state aid as part of bankruptcy proceedings while their senior creditors were shielded from losses.

This prompted complaints at the time from Berlin and some other capitals that the measures amounted to a loophole allowing nervous governments to get around the principle adopted by the EU in the wake of the financial crisis that investors, including senior creditors, should face losses before the taxpayer.

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The European Commission is set to review the bank resolution system next year. 

Via Financial Times