ECB preparing 'bad bank' scheme for potential Covid-19 toxic debt

Move aimed at shielding banks from further fallout if rising joblessness raises unpaid debt

LONDON • European Central Bank (ECB) officials are drawing up a scheme to cope with potentially hundreds of billions of euros of unpaid loans in the wake of the coronavirus outbreak, two people familiar with the matter told Reuters.

The project, which comes as Europe mobilises trillions of euros to bolster the region's economy, is aimed at shielding commercial banks from any second fallout from the crisis, if rising unemployment chokes off the income needed to repay loans.

One of the people familiar with the plan said the ECB had set up a task force to look at the idea of a "bad bank" to warehouse unpaid euro debt and that work on the plan had accelerated in recent weeks.

The ECB declined to comment on whether it was working on a bad bank scheme. The amount of debt in the euro zone that is considered unlikely to ever be fully repaid already stands at more than half a trillion euros, including credit cards, car loans and mortgages, according to official statistics.

That is set to rise as the outbreak squeezes borrowers and could even double to one trillion euros, weighing on already fragile banks and hindering new lending, the people familiar with the ECB plans said.

While the idea for a euro zone bad bank was discussed and shelved over two years ago, the ECB, under president Christine Lagarde, has consulted banks and European Union officials about a scheme in recent weeks, one of the people said.

One blueprint under discussion would involve the European Stability Mechanism, an EU institution which can provide financial assistance to euro zone countries or lenders, standing in as guarantor for the bad bank, the people said.

The bad bank would then issue bonds which commercial banks would buy in exchange for portfolios of unpaid loans, neutralising the virus shock for Europe's lenders. The banks could then lodge those bonds with the ECB as collateral for central bank funding, one of the people said.

Major European commercial banks could be called on to join forces to underpin the scheme, the second person said.

While European countries are now focused on launching a €750 billion (S$1.18 trillion) plan to help economies hit by Covid-19, the idea of a bad bank, and the ECB blueprint, could come up for discussion among central bank governors and ministers later this year.

Asked on Tuesday about bad banks, the ECB's chief bank supervisor Andrea Enria said that while he supported the concept, it was "premature" to discuss one now because it was not clear how severe the impact of the outbreak would be.

The amount of debt in the euro zone that is considered unlikely to ever be fully repaid already stands at more than half a trillion euros, including credit cards, car loans and mortgages, according to official statistics.

"I have been very supportive of asset management companies. I think they are useful," he told reporters, highlighting the success of bad banks in Spain and Ireland in the aftermath of the financial crisis. "Many of these schemes have ended up in the black, making profits."

Mr Enria said the ECB was studying how banks could cope if the crisis was to worsen. He said banks had more than €600 billion of capital and this would probably be enough, unless there was a second wave of infections.

Still, any pan-European scheme to tackle the problem of bad loans would likely face political objections from Germany, the euro zone's biggest economy, which has long resisted attempts to support banks in weaker countries for fear it could get lumbered with unpaid bills.

Mr Markus Ferber, a German member of the European Parliament, said Berlin remained opposed to taking on such mutual guarantees.

The European Commission, the EU's executive branch, said it had outlined how bad bank schemes could function, but no "formal work" was under way. It said banks had been given more regulatory leeway, but could "explore all relevant possibilities" if needed.

REUTERS

A version of this article appeared in the print edition of The Straits Times on June 11, 2020, with the headline 'ECB preparing 'bad bank' scheme for potential Covid-19 toxic debt'. Subscribe