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    ECB Highlights NPL Resolution as Key Policy Issue in Post-COVID Europe

    May 27, 2020

    As part of a Research Bulletin on the recent policy-relevant work, ECB published an article that examines the lessons learned from past crises for nonperforming loan resolution in the post COVID-19 period. As a result of the COVID-19 pandemic, the economy has come to a sudden halt. This is likely to bring about high levels of nonperforming loans. High levels of such loans are problematic because they impair bank balance sheets, depress credit growth, and delay economic recovery. The article highlights that designing effective nonperforming loan resolution policies for the post-COVID-19 world is a key forward-looking financial policy issue for Europe.

    In this article, the authors use a new database covering nonperforming loans in 88 banking crises since 1990 to find out the lessons learned. The authors use the “local projections” method to assess the link between nonperforming loan resolution and post-crisis output dynamics, while controlling for their co-dependence. The data show that dealing with nonperforming loans is critical to economic recovery, as high and unresolved nonperforming loans are associated with deeper recessions and slower recoveries. The results of the analysis highlight forces that can make nonperforming loan resolution after the COVID-19 events different from that after the 2008-2012 crisis. Compared with the 2008 crisis, some factors are conducive to nonperforming loan resolution this time: banks have higher capital, the forward-looking IFRS 9 accounting standards can help in recognition of nonperforming loans, and the COVID-19 crisis was not preceded by a credit boom. However, other factors that could make resolution of nonperforming loans more challenging are substantially higher government debt, lower bank profitability, and weaker corporate balance sheets.

    If the economic downturn proves temporary, many post-COVID-19 nonperforming loans may relate to viable illiquid firms, rather than unviable zombie firms. In contrast, if the economic recovery from the pandemic is slow and protracted, credit losses from corporate distress will rise and could overwhelm banks, further complicating nonperforming loan resolution. Thus, the analysis concludes that, given the importance of nonperforming loan reduction for economic recovery and many countries’ historical difficulties in implementing effective measures related to nonperforming loans, designing effective nonperforming loan resolution policies for the post-COVID-19 world is a key forward-looking financial policy issue for Europe today.

     

    Related Link: Article on COVID-19 and NPLs

    Keywords: Europe, EU, Banking, Credit Risk, NPLs, IFRS 9, COVID-19, NPL Resolution, ECB

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