ECB said to be mulling 'bad bank' option for Covid debt

Christine Lagarde, President of the European Central Bank. Photo: Daniel Roland/AFP via Getty Images

ECB officials are understood to be drawing up a scheme to cope with potentially hundreds of billions of euros of unpaid loans in the wake of the coronavirus outbreak.

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 source 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 scheme 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 eurozone 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 Covid-19 outbreak squeezes borrowers and could even double to €1tn, weighing on already fragile banks and hindering new lending.

While the idea for a eurozone bad bank was discussed and shelved over two years ago, the ECB, under its new President Christine Lagarde, has consulted banks and EU officials about a scheme in recent weeks, a source said.

As the eurozone’s most powerful institution, ECB backing for the project is critical but it would also require the blessing of Germany, the bloc’s biggest economy.

Berlin has long opposed schemes that accept shared responsibility for debts in other countries although it recently had an unexpected change of heart, agreeing to pool EU borrowing for a coronavirus recovery fund.

One blueprint under discussion is understood to involve the European Stability Mechanism, an EU institution which can provide financial assistance to eurozone countries or lenders, standing in as guarantor for the bad bank.

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.

Major European commercial banks could be called on to join forces to underpin the scheme.

While European countries are now focused on launching a €750bn 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.

Andrea Enria, the ECB’s chief bank supervisor, said while he supported the concept of a ‘bad bank’, it was “premature” to discuss one now because it was not clear how severe the impact of the coronavirus outbreak would be.

-Reuters