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Too little, too late for NPL reform

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By Tom Brown
10 Mar 2020

Last year was the first since the crisis that European markets ducked under NPL ratios of 3%. It would have been a cause for celebration, if not for the coronavirus outbreak marauding the continent, ready to bring a new generation of non-performing assets to bank balance sheets.

Banks in the EU still hold around €731bn of non-performing assets — debt which law makers no doubt hoped might have recovered a decade after the sovereign debt crisis. The problem is worst in Italy, Greece and Cyprus.

In December 2018, the EU agreed to take a second look at NPLs, hoping to bring the rules governing the permissable level of NPL exposure for a bank in line with Basel Committee's minimum capital requirements. This would have involved changing the definition of what a technical default was, as well as requiring banks to set extra money aside to deal with defaulted loans.

The rules demand that banks hold more capital and for longer against non-performing exposures. But for banks under strain from market volatility, overbearing bank regulation could not be coming at a worse time.

With the coronavirus outbreak wreaking havoc across the continent and its economies — especially in Italy — it may be too little, too late for the fight to protect against NPLs. Increasing bank capital charges will do more harm than good at a time when those same financial intuitions are supposed to be letting customers take payment holidays from their mortgages where they have been affected by Covid-19.

Italy, the continent’s biggest NPL exporter, looks by most metrics to be headed for a recession. The country did the most work shifting NPLs off of bank balance sheets with the help of a government guarantee programme, helping to halve them in terms of volume since their 2014 peak.

Now, with the entire country in lockdown, the prospects of dealing with the other half are not looking promising.

Italian banking association ABI asked the EU policy makers to forestall the new rules, granting it a respite for up to a year while the country recovers from the economic ravages of the outbreak. Even if the virus stops spreading, European banks will need time to recover from routed markets and dashed earnings.

If approved, it may show that the policy tools used to guide the market after the last crisis are insufficient for dealing with the new one.

Eventually, the scale of the outbreak will catch up with the legislators and any attempted NPL reform will at best be put on hold. By the time it gets a second look, there may be a whole new wave of NPLs for the ECB to process, with Italy at the forefront once again.

By Tom Brown
10 Mar 2020