Euro banks keep bad debts on books

Loose monetary policy makes it easy for euro-area banks to keep bad debt on their books, potentially delaying the flushing out of sour loans, the Bank for International Settlements said in its annual report.

The European Central Bank’s record low interest rates and ample liquidity have boosted banks’ lending margins, allowing them to gloss over losses in their business, the Basel, Switzerland-based BIS said in the report, released yesterday.

That’s what makes it so crucial to find other means to fix banks’ balance sheets, such as the ECB’s asset-quality review, it said.

“Enforcing balance-sheet repair is an important policy challenge in the euro area,” said the BIS, the record-keeper of the world’s central banks. “Low rates reduce the cost of — and thus encourage — forbearance, keeping effectively insolvent borrowers afloat in order to postpone the recognition of losses.”

Non-performing loans have kept growing in the years since 2010 in euro-area countries such as Spain or Italy, where they exceed 10% of all loans. Meanwhile, they dropped to less than 4% in the US last year, down from a peak of about 7.5% after the 2008 collapse of Lehman Brothers Holdings Inc.

In its assessment of the euro area’s 128 largest lenders, the ECB will seek to determine whether firms are giving borrowers easier terms to avoid showing loans as defaulted.

“The experience of Japan in the 1990s showed that protracted forbearance not only destabilises the banking sector directly but also acts as a drag on the supply of credit,” the BIS said. “This underscores the value of the ECB’s asset-quality review, which aims to expedite balance-sheet repair.”

The bad loans on banks’ books are running counter to their strengthening of capital ratios, the BIS said.

ECB president Mario Draghi is combining different tools as he tries to simultaneously heighten banks’ risk awareness and prompt them to lend in countries coming out of recession.

While the ECB’s scrutiny of balance sheets puts pressure on banks to clean their books, Draghi is also offering as much as €400bn of cheap funding to jump-start lending that is still lacklustre a year after the 18-nation euro area emerged from its longest recession.