Bail out people, not banks

The European Commission announced on December 16 an Action Plan for tackling non-performing loans (NPLs) in the aftermath of the Covid-19 pandemic. Offering a host of solutions mainly centered on creating a secondary market for NPLs and creating the conditions for so-called precautionary recapitalisation of banks (in other words publicly funded bailouts), it arrived one month before the European Parliament’s Economic and Monetary Affairs Committee (ECON) sent a clear signal that it intends to clean up the conduct of companies that deal with non-performing loans.

While the Commission seeks how best to treat NPLs from the supply side and the Parliament addresses the question of how best to protect borrowers for the future, we still have a question to address: how do we protect financial stability whilst ensuring that the Covid-19 crisis does not degenerate into a people’s tragedy? One solution is for governments to pay off the loans people cannot afford to repay.

If that seems too simple, look again. In comparison with the creation of a secondary market for NPLs combined with a bail-out of banks, paying off people’s loans would achieve two results. First, it would remove the loans from the banks’ balance sheets at face value, thereby protecting the banks from taking the losses that they would take if they sell the same loans at a discount in a newly created secondary market, which in turn would avoid the need for recapitalisations. Second, it would help individuals and avoid seeing them dive deeper into the trap of over-indebtedness with all its dire consequences.

Timing is everything

Bailing out people is timely, and elegant. Exceptional times require exceptional measures. Covid-19 ravages economies, communities and hope. Last year’s lockdowns caused the economy to crash. Governments forced many businesses, especially those in hospitality, arts and exercise, to suspend trading. Entrepreneurs and the self-employed were often left in the lurch.

People saddled with too much debt have become a big problem for banks. As jobs loss and business failures persist, growing numbers are unable to pay their mortgages, business loans, or both.

The outlook for many of these people is grim. Governments are doing their part to help people through national furlough schemes and making money available to SMEs. The EU Recovery and Resilience facility, when completed, will provide additional succor. Governments initiated debt moratoria and payment suspension. This puts strain on banks but helps those borrowers in a tight spot.

But such measures are not enough and won’t be enough. They merely bandage a bigger wound. The NPL problem is a threat to financial stability, and a brake on economic recovery which, according to a recent IMF forecast, won’t recover pre-pandemic levels until mid-2022 at best.

A pound of cure 

Over-indebtedness undermines all efforts to solve the NPL problem – and policymakers are starting to acknowledge it. EU Commissioner Didier Reynders recently announced that the Commission will add more funding for debt advice in Member States. January’s ECON committee approval of amendments to the Credit Servicers Directive shows that Europe needs and wants to protect borrowers.

That’s good for future borrowers, but does nothing for people drowning in debt right now. They need a bailout because our societies cannot afford to leave millions of citizens on the side of the road, and because they pose a stability risk for banks. Amending consumer protection legislation will not help the already over-indebted, but rather those who will borrow in the longer term.

Looking beyond traditional retail banking, latest research commissioned by Finance Watch in three EU Member States reveals a troubling trend. As the pandemic wears on, consumers increasingly seek small-value loans that borrowers rarely repay from finance companies charging usurious interest rates. These loans, from fringe outfits in the market, pose a big challenge for Europe’s cash-strapped treasuries which can little afford to pay for the physical and mental health problems, social struggle and household economic meltdowns brought on by such lending.

Supply side hazards

Stronger rules will work, but bailing out banks will not.  One lesson of the financial crisis was that bank bail-outs create moral hazard and adversely distort banks’ approach to risk.  There is little public support remaining for rescuing privately owned financial institutions from crisis effects.

A borrower bailout with stronger borrower protection

While governments and banks wade through the NPL mess, Europe finds itself at a crossroads. Against a backdrop of climate change, a global pandemic and economic uncertainty, some people, especially in essential sectors, put their lives and future health in peril. Meantime many banks are reluctant to lend because of the looming NPL crisis. That approach helps no one, especially the households and SMEs that are short of cash and struggling to survive. If we bailed out people, banks would have no good reason to hold back on lending.

Bailing out people to sort out the past and adopting stronger borrower protection rules to prepare for the future would be a powerful combination to combat the terrible human, social and economic consequences of over-indebtedness which have been amplified by the Covid-19 crisis.

Think of it this way: for banks, bailing out over-indebted people brings the same benefit as a recapitalisation when it comes to restoring their balance sheets; for the people receiving the bail-out, it means avoiding the devastating impact of over-indebtedness and thereby the chance of living a life worthy of human dignity; for society it means a much better use of public money and avoiding the  downside of bank bailouts, not to mention their limited political acceptability.

There should be no hesitation.