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Bad banks need to be a domestic affair

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A eurozone bad bank would have been difficult to institute even without the coronavirus crisis to spur it on. Now, with countries diverging on moratorium measures in response to the pandemic, it’s verging on impossible.

The calls for a European bad bank — like those for pan-EU sovereign bonds — are not new. Both ideas have been floated ever since the European sovereign debt crisis almost a decade ago, gaining particular prominence in the middle of the last decade after non-performing loan (NPL) levels remained high in bailed out countries like Cyprus, Greece and Portugal.

But in 2018, by which time Portugal and Cyprus had developed their own NPL markets — disposing of debt mostly through private securitizations of bad debt or portfolio sales — calls for a European bad bank died down. Markets had developed independently of European Central Bank efforts, and countries like Greece were noting the success of Italy’s NPL securitization scheme (GACS) and set to developing their own.

Then the pandemic struck and the clamour for mutualised debt rose again. It has become clear that Europe will once again have to begin preparing for a new generation of soured, defaulted loans to pile on top of what remained from the 2008-2012 bin ends.

This would have been a Herculean task before the coronavirus crisis, but thanks to countries going their own way on pandemic response packages, the problem is now two-fold.

The first regards harmonisation. There needs to be a common standard for a bloc-wide soloution to work but countries have vastly different debt problems. Without a harmonised fiscal policy, EU institutions have their work cut trying to shift debt on an international scale, as outlined by GlobalCapital on Monday.

The second and more immediate problem is simply one of classification — how do you spot a non-performing loan? This has been made more difficult by the fact that a harmonised strategy was not adopted across Europe when granting loan moratoriums.

The Netherlands, for example, does not require borrowers to prove they have been financially impacted before taking a mortgage payment moratorium, whereas most UK banks, for example, require this from their customers.

For a servicer, how does one distinguish between loans a borrower has opted not to pay voluntarily, versus those made to a borrower who has taken a moratorium? Based on recent bank earnings reports, individual lenders have not yet even created a category for such loans, let alone devised a harmonised approach on how to get them paying again.

Pleasing all would in this case mean pleasing none, as the only acceptable compromise would be to follow the lowest common denominator, an approach which would hobble the recovery in the rest of the eurozone.

The idea of a eurozone-wide bad bank is little more than another gambit from those intent on harmonising EU debt and debt consolidation. But to put the burden of NPL disposals on international institutions would be to undo the years of work which went into setting up national schemes.

Instead, EU institutions should focus efforts on easing up state-aid rules, foregoing non-performing exposure targets for 2020, and granting banks more guidance on how to consolidate loans which have been granted moratoriums.

Temporary solutions could be arranged, backed by the European Central Bank and the European Banking Authority, whereby NPL schemes are implemented at a national level, purchasing soured loans from bank balance sheets, then either selling the assets back to the banks once the loans are resolved after a set period, or disposing of the loans in a traditional portfolio sale if the loans have not recovered.

NPL schemes at a national level have proven themselves effective at reducing NPL volumes. With a little extra breathing room, EU member states might achieve even more on their own than they already have without having to wait for a lumbering behemoth to come along from Brussels to do the same job for them.

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