June 19, 2018 / 9:21 AM / in 3 months

ECB seeks compromise solution to banks' bad loans problem

SINTRA, Portugal (Reuters) - European Central Bank supervisors are looking for a softer way to press euro zone lenders to deal with their bad loans after an earlier proposal met fierce opposition, two sources said.

FILE PHOTO: The logo of the European Central Bank (ECB) is pictured outside its headquarters in Frankfurt, Germany, April 26, 2018. REUTERS/Kai Pfaffenbach

Even after a sharp reduction in the past two years, euro zone banks are sitting on 721 billion euros ($837.01 billion) of unpaid debt, mostly inherited from the 2008-12 economic crisis and concentrated in countries such as Italy, Greece and Portugal.

Plans by the ECB’s Single Supervisory Mechanism (SSM) to introduce rules forcing banks to set aside cash against that soured credit within a given timeframe has met with resistance from bankers, lawmakers and even within the central bank.

After months of delay, supervisors from the euro zone’s 19 countries are honing in on a compromise solution the would allow the watchdog to save face and be acceptable to weaker countries, the sources told Reuters.

This could involve giving banks a number of years to provide for the bad loans, as the original proposal suggested, while introducing exceptions, for example for countries where a slow judicial system makes recovering collateral laborious, such as Italy.

Alternatively, supervisors could ditch such a so-called calendar-based approach altogether and divide up banks and loans in “clusters”, based on what proportion of their book has gone awry or whether they are exposed to an industry with known problems, such as shipping.

“They have to find a balance between a calendar-based and a case-by-case approach,” one of the sources said.

A decision was likely this summer, the sources said.

It was the SSM’s last-ditch effort to salvage the final piece of a three-year, concerted effort to draw a line under the euro zone’s debt and banking crisis.

The chair of the SSM, Daniele Nouy, has until the end of the year to establish her legacy before stepping down, followed a month later by her deputy Sabine Lautenschlaeger.

But the issue of unpaid loans has driven a rift between a handful of countries where banks still have large numbers of bad loans such as Italy, which did not bail out its banks during the crisis, and the rest.

This has caused the SSM to delay the publication of the new rules, originally expected in March.

The SSM said in April it was considering whether further policies on legacy non-performing loans (NPLs) were necessary at all “depending on the progress made by individual banks”.

Sources told Reuters at the time that if the rules were scrapped, supervisors would look to continue putting pressure on problem banks using existing powers.

The SSM has already introduced rules on loans that go unpaid, giving banks seven years to provide for them if they are backed by collateral and two if they are not.

The SSM had initially envisaged applying these rules to the stock of legacy loans.

But an impact-assessment study by staff in the ECB’s monetary policy arm highlighted risks to the financial system because some banks would be forced to set aside billions of euros to provide for their soured credit.

This has proven an elusive feat for weaker banks such as Italy’s Monte Paschi, which needed state help in late 2016 after failing to raise money on the market.

The SSM, which is formally separated from the rest of the ECB, had come up with a more benign outcome by assuming banks would continue reducing their stock of bad loans, as they have done for the past two years.

($1 = 0.8614 euros)

Reporting By Francesco Canepa; Editing by Andrew Heavens

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