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Reducing Non-Performing Loans (NPLs) in the EU Banking sector

Reducing Non-Performing Loans in the EU Banking sector

Can Europe’s €1.05 trillion stock-pile of NPLs be cleared without public sector intervention?

Marcus Evans

Partner, Financial Services

KPMG in the UK


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Business people in meeting room discussion

Policymakers roll up their sleeves

Can Europe’s €1.05 trillion stock-pile of NPLs be cleared without public sector intervention? Rephrasing the question: will the private sector alone be able to cleanse banks’ balance sheets? The answer of policymakers in Frankfurt (ECB), Brussels (European Commission) and London (European Banking Authority) appears to be ‘No’, with an increasing degree of intensity and unity.

In a recent keynote speech at Bruegel, the Vice-President of the ECB Vitor Constâncio outlined the scale of the task. He noted that in the six euro area countries with the highest NPL ratios, the average 2016 NPL ratio is 22.8% compared with 4.8% (average) for the same countries in 2007. By contrast, in both the United States and United Kingdom, the 2016 NPL ratio stands only 0.1% higher than in 2007 (2016: 1.5% in the US, 1.0% in the UK). The slower cleansing of balance sheets post-crisis appears to be somewhat a European exception. It also affects Banking Union countries unevenly. In Cyprus and Greece, approximately half of total loans are non-performing (equating to one third of total bank assets) and a further four countries report ratios of circa 20%, but many euro area countries maintain NPL ratios below 3%. Mr Constâncio states that “one of the main reasons we are concerned about high NPLs, from a macro-prudential perspective, is that they weigh on bank profitability”. Policymakers are also concerned about their impact on economic growth, due to NPLs tying up bank capital, constraining fresh lending, and the Monetary Transmission mechanism: if clients are not re-paying interest, this constrains banks’ ability to pass on base-rate changes. 

In a presentation on 30 January 2017, Andrea Enria, chairman of the EBA, proposed a solution for managing NPLs in the Eurozone: setting up a common asset management company (AMC) that would manage the sell-down of NPLs, or in other words, a European “bad-bank”. Could this be a practical solution to this Eurozone’s NPL challenge? The following provides a high-level overview of the proposed AMC mechanism and comments on the challenges of establishing it.

How would a European AMC operate?

The AMC would work by seeking to bridge the difference between the real value in economic terms of banks’ NPLs and the price that an investor would willingly pay (‘the bid-ask spread’). The bad bank would identify assets to be bought and estimate what their real economic value is (i.e. the estimated value of the asset without market failures and in some cases assuming reduced structural inefficiencies over time). The selling bank would take some upfront losses on transfer to the AMC, due to the AMC buying below-book, but above current market prices. The AMC would then hold the assets for a period and seek to maximise recoveries. Should the AMC fail to meet the targeted recovery from a loan portfolio, it would have recourse to claw-back some of the shortfall from the selling bank (which may by then have generated or raised additional capital). 

Through such a mechanism, banks would be able to clean their balance sheets and have NPLs managed by a pan-European entity, leaving them to concentrate on driving productive growth. According to Klaus Regling, managing director of the European Stability Mechanism, as much as €250bn of loans would ideally be transferred to the bad bank, thereby creating a one-stop shop for investors and stimulating sales which are currently not sufficient to deleverage European NPLs, as set out in KPMG’s Debt Sales report. 

Potential and operational challenges

From an operational perspective there would be considerable challenges in the creation of a European AMC. If it were a centralised structure, the AMC would need the capability to service, workout or sell any asset class, in any Banking Union country (and, doubtless, beyond). Such breadth of expertise, covering all EU insolvency frameworks, loan structures and languages has probably never previously been assembled in a single entity (public or private). Established and successful AMCs, such as NAMA in Ireland and SAREB in Spain, have had more narrow remits, focusing primarily on home-market Real Estate. 

The AMC designers would need to build within the constraints of State Aid rules and the BRRD resolution framework and are fully cognisant of this. A further challenge will be managing political complexity surrounding valuation: how would the AMC defend its acquisition prices in different countries? Valuation deltas between countries (for similar assets) would be transparent and illustrate national structural inefficiencies. Running an Asset Quality Review (AQR) on NPL assets to be transferred may be part of the solution and would drive transparency. This would, however, require greater ‘national calibration’ than occurred in 2014, when the ECB AQR focused more on creating a ‘level playing field’ for loan valuation and consequently produced (in our view) a narrower range of credit values than market investors. Designing an AQR which takes full account of differences in national insolvency law, staffing of judiciaries and so on would be tremendously complex. The ECB or EBA would (presumably) need to be the arbiter for both design and valuation processes. 

If a central AMC were not created at a European level, it is still possible that the EBA’s proposal could provide a blueprint for national AMCs. We would see merit in this, as a national AMC could remain more agile than an ‘EU bureaucracy’ would be perceived to be, and could also target ‘strategic defaulters’ with more immediacy and effectiveness than potentially remote European AMC.


In Mr Constâncio’s conclusion, he stated: “a comprehensive, co-ordinated effort on the part of several European and national authorities is now crucial” The development of a secondary market for NPLs through the creation of the pan-European AMC may well be the solution the Eurozone requires. We believe that such AMCs should be established by country, reflecting local specificities, and perhaps also by asset class. 

There are many ingredients needed to tackling the NPL overhang in Europe. The SSM’s NPL Guidance (PDF 990 KB) is key in requiring banks to play their part. Policymakers are now rolling up their sleeves and we are likely to see European AMCs being added to the ‘NPL deleveraging toolkit’ in the months ahead. Replicating the successes achieved by AMCs in Ireland and Spain is a noble objective, but the operational and political challenges inherent in a pan-EU AMC design should not be underestimated. 

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