IMF published its staff report and selected issues report in the context of the 2017 Article IV consultation with member countries forming the euro area. The Executive Board of IMF concluded that structural weaknesses in the European banking system in the form of weak profitability and pockets of high non-performing loans (NPLs) could trigger financial distress. A comprehensive approach to reducing NPLs is required, including through strict supervision, modernizing insolvency and foreclosure frameworks, and further developing distressed debt markets. Expeditiously completing the banking union and advancing the capital markets union also remain essential.
The staff report highlights that high NPL stocks in some countries hinder adjustment and monetary transmission. Over the last two years, NPLs in the euro area have been reduced by about EUR 160 billion, but the stock remains high at about EUR 1 trillion. More than 90% of the reduction in NPLs is accounted for by larger banks and over 60% has occurred in Spain and Ireland. In Italy, which has the largest stock of NPLs, progress has been too slow, with NPLs falling by only about 5% relative to the 2015 peak level of EUR 324 billion. Household debt has been the predominant component of NPL reductions while corporate debt accounts for a small share of the reduction, implying that corporate NPL stocks remain stubbornly high. Directors encouraged the EC to provide a blueprint for national asset management companies and clarity on State Aid requirements, which could help develop markets for distressed debt.
Moreover, restructuring and consolidation in the banking sector should be incentivized by a firm approach to closing failing banks. Directors noted that the upcoming review of the Bank Recovery and Resolution Directive (BRRD) presents an opportunity to address any impediments to bank resolution. Directors considered completing the banking union—with common deposit insurance and a common fiscal backstop—as an essential complement to risk reduction in the banking sector. They also noted that ring fencing of capital and liquidity within countries runs counter to the concept of a banking union. Directors agreed that Brexit gives greater urgency to building a capital markets union and that supervisory capacity needs to be correspondingly upgraded. The overall low euro area return on assets, with a return on equity well below the cost of equity, raise doubts about the sustainability of banks’ business models and their ability to adapt to a stricter regulatory and supervisory environment along with the growing challenges posed by fintech.
The selected issues report examines, among other issues, the financial stability risks from Euro area insurance and pensions sector. Insurers in Germany, France, and Austria are most vulnerable to market risks due to the prevalence of both guaranteed products and large asset-liability duration mismatches. But comfortable solvency buffers in France and Austria provide some protection. Although the shortfall in buffers of a ¼% of euro area GDP arising from the severe downside scenario in the 2016 stress tests of the EIOPA is modest, these shortfalls are higher for high-debt countries and could be even higher if shocks were amplified through domestic interconnectedness.
Keywords: Europe, EU, Banking, Insurance, NPLs, Banking Union, Capital Market Union, BRRD, IMF
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