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September 22, 2017

Pentti Hakkarainen, Member of the ECB Supervisory Board, spoke at the ESRB Annual Conference in Frankfurt, about the challenges and future of banking in the EU. He discussed the profitability and business model sustainability of euro area banks, along with the legacy issue of nonperforming loans (NPLs), providing thoughts on why and how banks should progress further toward solutions in this area.

He highlighted the high level of NPLs, with the weighted average NPL ratio across significant euro area banks now being below 6%; however, in a few countries this number is above 40% and in too many cases it remains above 10%, thus reflecting that many euro area banks have successfully managed to avoid this problem. “Research, and also our practical experience to date in addressing NPLs during the crisis, indicate that a proactive approach pays off,” he added. Good bank business models must be resilient to macroeconomic shocks. Banks, therefore, require a cautious approach that builds-in the capacity to cope with major macroeconomic downturns. Such prudent management implies limiting risk appetite ex ante. This will involve due consideration of— hedging, risk buffers, capital cushions, and limitations to credit risk in the good times. Where banks have not done this—and where they therefore face big ex post challenges—they should face the consequences of their choices, otherwise long-term incentive problems will arise.

 

Banks should recognize that they are the primary owners of any asset quality and NPL problems that may have arisen. In particular, banks should not sit on their hands in anticipation of a big public sector solution that will save them from the pain of cleaning up balance sheets on their own. Banks must act swiftly now to take all the relevant steps at their disposal to address this issue. This said, I also acknowledge that in some cases it is understandable and even desirable to use an element of public support within the set of solutions. There are several initiatives to solve the problem with public money and, as time is of the essence, swift solutions like national Asset Management Companies could be well justified. Mr. Hakkarainen concludes that “Primary responsibility for solving such problems should always lie with the banks.”

 

Related Link: Speech

Keywords: Europe, EU, Banking, NPLs, Asset Management Companies, Credit Risk, ECB

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