Since the Great Recession struck the world economy and banks started to crash because of the Real Estate Bubble excesses, the European financial system improved its health since then with managers at European Banks making an effort to adjust to the post-crisis landscape. However, as a result of the slow recovery and some regulatory obstacles, the banking system has still some issues that need to be fixed.
The first one is related with the high ratio of Non-Performing Loans (NPLs), those loans where the debtor is in default or close to it; they are especially important on peripheral countries such as Portugal, Cyprus, Greece or Italy. This high ratio forces banks have to store more capital in order to cover for future possible loses and so they have less capacity to lend. Therefore, firms have less investment capacity what affects the speed of the recovery and so the reduction of unemployment. To decrease this number, tightening bank supervision and, at the same time, improving the process to declare a firm in bankruptcy to accelerate debts collection is very important. The reason is that within the actual legal margin, banks let NPLs too long on their books due to the difficulty of recovering the assets left as collateral (those countries with a higher NPLs ratio are also those facing the most long and costly procedures to recover the collateral). Recognizing NPLs is a very important step because it incentivizes to find a solution. To liquidate assets quickly, it is also a good thing to develop a legal framework to trade those assets, from banks to investors specialized on them. This is a good alternative approach to get money without having to wait until the firm liquidation process is over.
Another problem stems from the purchases of government debt that the banks conducted, which created a dangerous link despite the efforts of the EU to avoid that if some big bank crashes, it does not drag with him it respective country as occurred with Ireland or Cyprus. Although now there is the Single Resolution Mechanism (SRM) that would provide European funds to recapitalize the institutions, it does not protect if a country ends up not paying its obligations. If this happens, banks would suffer because they are heavily exposed to government debt and so credit would dry.
Together with the SRM, the EU stablished a set of new common rules for all the European banks. Among them, there is the bail-in policy, i.e. shareholder and bondholder would be forced to accept some loses to avoid the failure of the institution. To satisfy these new requirements, banks issued “coco bonds” a sort of bonds that when a bank loses money or its assets collapse in value, the bondholder loses money as well. These bonds are spread among the credit market so if some bank fails, it may create problems on other banks that invested on those assets.
Banks are today much better than 8 years ago because they reduced significantly its leverage, increased its capital and do not face any liquidity problem. However, they still face some problems that need to be fixed through improvements of the legal system to speed up the bankruptcy process and the liquidation of the impaired assets. Additionally, thinking how to solve the problems given by complex assets as the “coco bonds” and to renegotiate the debt of those countries that will face more problems in the future to make it sustainable is important too.
Jochen Andritzky, Niklas Gadatsch, Tobias Körner, Alexander Schäfer, Isabel Schnabel, ʽA proposal for ending the privileges for sovereign exposures in banking regulationʼ (March 4th 2016). Voxeu, Online (May 3rd 2016 at 17:03)
Gabriel Bracons Font, student of 4th year of the degree in Economics in the UPF and colaborator in Pompeunomics