Is a European Bad Bank coming?

The Financial Times reported on Sunday that high-level talks had taken place between representatives of the ECB and the EU Commission on the possible creation of a bad bank for the eurozone. The bad bank could take over billions of dollars worth of non-performing loans (NPLs) from banks, thereby cleaning up their balance sheets. It appears to be a matter of NPLs that still originate from the financial crisis of 2008/09.

The idea of a bad bank to relieve banks of NPLs is not new. Ireland, Germany and Spain, for example, founded liquidation companies in the wake of the financial and European sovereign debt crisis and used them to reduce non-strategic assets and NPLs. A European bad bank was also examined in detail at the beginning of 2017 as part of a possible solution to the high NPL portfolio on behalf of the EU Commission. The establishment of national or a European bad bank could undoubtedly play an important role in relieving banks of rising NPLs and thus creating space for the granting of new loans.

Ultimately, however, it will depend on the concrete design of the bad bank so that it can develop its full impact. For example, a restriction to old NPLs would not be target-oriented, but the transfer of new corona-conditioned NPLs would also make sense. The transfer prices must be sufficiently attractive so that as many banks as possible use this instrument. In order to reduce incentive conflicts, supplementary liability should be agreed for the respective own NPLs, whereby these may only be used after a certain number of years. In this way, the capital ratios of European banks would be immediately and noticeably relieved by the outsourcing of NPLs, without being completely released from responsibility. However, the success of such a model is strongly based on the fact that one only has to bridge a temporary economic slump and that credit losses are not as high as feared. If this were not the case, the NPL problem would not have been solved, but merely postponed into the future. In that case, the instrument of creditor loss sharing might have to be used.

This discussion is not new and has so far always failed due to the question of how to prevent permanent communitarisation and false incentives. The heated debate on the introduction of corona bonds shows here that the fundamental positions have not shifted over the years for good reasons. A subsequent communitarisation of debt or NPLs cannot be a viable basis for economic recovery in the long term. Temporary and earmarked instruments, on the other hand, can provide the right impetus. This applies to new bonds, as well as to a bad bank at the ECB.

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