June 10, 2016    5 minute read

Non-Performing Loans Are Holding Europe Back

   June 10, 2016    5 minute read

Non-Performing Loans Are Holding Europe Back

It has been eight years since the financial crisis shook the global economy to its roots. The dry cleaning process, to polish up European Banks Balance Sheets, is still underway. Banks have been dealing with the enormous task of deleveraging their non-performing loans (NPL) since the meltdown happened and it is estimated that it will take 5 or more years to do so. NPL’s and non-core loan assets held in the European banking sector totalled in 2015 to more than €2 trillion in value. To highlight the scale of this amount its worth comparing it to the M&A market between 2003 and 2010, which totalled to only €70 billion.

NPL’s occur when banks consider that an obligor won’t be able to repay its full credit obligation after its 90 days overdue. The timescale after which loans are considered overdue varies from countries within the Eurozone, therefore, caution is advised while comparing increasing volumes of NPL’s between the member-states. The following graphic shows the development of NPL ratios in Continental Europe.

Non Performing Loans

(Source: IMF)


Why are NPL’s so significantly correlated to credit growth, an important factor for the strength of the Eurozone regarding its economic outlook?

The Eurozone is struggling with bad loans. NPL ratios are still quite high especially in the PIG countries and are a major reason why the Eurozone is not back at the level it would like to see itself. At the end of September 2015, Greece and Cyprus reported more than 40% in NPL ratios. Portugal’s ratio was at 18.5%, Italy’s at 16,9%. Spain improved due to new regulations being implemented by the Bank of Spain and is currently at 6.8%, whereas Ireland has a ratio of 20.6%. Each member of the EU has on average a 10.47% ratio of non-performing loans compared to reported ratios from the World Bank for the U.S. and Japan of respectively less than 2% each at the end of 2015.

Europe versus United States in its NPL ratio evolution 

Non Performing Loan Development

The EU’s economic backbone are the many SME’s which rely traditionally more on financing from banks and hence find themselves in a harsher environment if their countries banks have high NPL ratios. Non-performing assets held on banks’ balance sheets weigh on the ability to lend to the real economy through mainly three negative implications:

Higher capital requirements: NPL’s, due to their risky nature compared to performing loans, tie up banks’ resources. A timely release of currently impaired assets would release over €42 billion additional capital. This would vastly contribute in unlocking lending amounts of more than 5% of Eurozone GDP, according to the IMF. Euro-Banks with higher NPL ratios have been lending less over the past years, mostly in countries where businesses needed new loans to continue operation.

Lower Profitability for banks: It takes more resources to manage substantial NPL stock, which in turn decreases net operating profit.

Increased funding costs: Interbank lending is more expensive for banks with high NPL ratios related to less willingness to lend by market participants. This leads to a negative impact on the banks’ capacity to generate profits and close new deals with businesses.

Non-Performing Loan Portfolios are becoming more popular amongst institutional investors. In 2015, loan sales activity almost doubled compared to 2014 and projections for 2016 forecast over €130 billion in transaction volume. It is worth pointing out Italy as the Eurozone’s third largest economy. The country still hasn’t seen the wished for recovery but is on the right track. The European Central Bank has been in talks with the Italian government over plans to purchase over €200 billion in bad loans, as part of its Asset-Purchase Programme, to speed up the slow transaction market in Italy.

Sales of NPL portfolios are made at a discount in so-called “Special-Purpose-Vehicles” (SPV) and will give the Italian banks a chance to clean somewhat of their balance sheets, despite having a rather small short-term impact, but providing improved value in the sales of the SPV’s to the ECB compared to sales in the market. Over 80% of bank NPL’s in Italy are in the corporate sector. The Bank of Italy is advocating to restructure the NPL market in Italy to allow banks to address their distressed assets more efficiently. Recently implemented reforms made write-offs tax deductible. Before these changes, Italy used to penalise banks that tried to aggressively write off their NPL’s. This portrays how restrictive the market in Italy still is compared to other member’s states. Recently the Italian government and the EU agreed on a new design of facilitation for offloading NPL portfolios to private investors. The senior notes of the SPV’s will be guaranteed by the government and enable an increased transaction volume and speed up the process of reducing Italy’s non-core assets in its banking sector.

Italy’s North-South Divide in 2015


European Banks, especially in the PIG states, still have great length to go until the full potential of credit creation can be offered again on the same level as of pre-2008. The PIG states will for years coming continue to require the help of the ECB and new regulations to free themselves from their impaired assets. Only then it will be possible for the whole of Europe to completely start over, free from old burdens. The tedious clean up of non-core assets has already gained significant pace this year, and it looks promising that the member-states, by combining efforts, can solve the last big problem of Europe’s Banking Sector.

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