Tackling non-performing loans in the aftermath of the Covid-19 pandemic

Thank you for inviting me in this hearing. It will be an honour for me to share a few thoughts with you today and try to find solutions to the very serious problem of tackling non-performing loans in the aftermath of the Covid-19 pandemic. As requested, I will also comment on the preliminary draft opinion produced by the EESC on the subject following the Communication made by the European Commission on 16 December.

If I were a banker or, should I say, if I were still a banker, I would love the proposal made by the European Commission to create a secondary market for non-performing loans, which is at the heart of its December Communication. The former trader knows that opaque markets are an excellent way to make nice margins, and experience tells us that such a market would by construction be opaque.

Unfortunately, I am not a banker or a trader anymore, and I tend to look at the tools proposed to address a problem through a rather simple lens: ‘”Do the tools proposed bring a solution to the problem identified, or not”? I happen to be completely agnostic on the question of knowing whether a market is good or bad. To be honest, I always find that question rather awkward: a tool is a tool and it is neither good nor bad. In the real world, a tool can be adapted to a situation or not adapted to another one, and this is also the case for markets.

We are being asked a simple question today: “Is the creation of a secondary market for non-performing loans the right tool to tackle the terrible situation of over-indebtedness arising from the pandemic and its economic and social consequences?” As we know, this is one of the most important questions society has to deal with at the moment.

In order to answer this question, we have to specify the problems. Once we have done this specification, we will ask ourselves whether the solution proposed, namely to create a secondary market for non-performing loans and prepare for so-called precautionary recapitalisations of banks, addresses the problems.

We have three problems to tackle:

1. Ensure financial stability in a context where too high a level of non-performing loans could create difficulties for some banks and therefore create a financial stability problem given the interconnectedness of the European banking system;
2. Ensure that banks can lend to the economy despite the hit they will take from the rising level of non-performing loans;
3. Avoid, for people as well as small and medium-size enterprises, the devastating impact of over-indebtedness, something obviously indispensable for the continuity of the economic and social structures of our societies.

Put simply: How do we protect financial stability whilst ensuring that the Covid crisis does not degenerate into a people’s tragedy?

Let us look more closely at the solution proposed to the problems identified.

Will the creation of a secondary market for NPLs resolve the financial stability question? Once the market has been created, banks will sell their NPLs at a discount, thereby realising a loss that was until then potential. Clearly, this does not resolve the financial stability issue: when money is lost, it is lost, and whether the loss is realised through a sale or unrealised if the loans remain on the balance sheet of banks, does not change anything. Incidentally, as we know, when the amount of money lost exceeds the own funds of a particular bank, that bank is doomed to default. Unfortunately, the creation of a secondary market for NPLs is not a miracle solution to avoid this economic reality, as it will not make money that was lost reappear.

Will the creation of a secondary market for NPLs resolve the question of the over-indebtedness of people or of small and medium size enterprises? Here again, the answer is “no”: when money is owed, it is owed. This basic truth will never be changed, and a secondary market will not prevent people and small businesses from being trapped into over-indebtedness. As we also know, this situation will create huge social, economic and political problems as millions are left on the side of the road. On that front, I have to admit that the European Commission’s stated objective, in point three of its December Communication, for Asset Management Companies purchasing NPLs “to extract the most value from (NPLs) by active workouts” leaves me more than worried for the fate of debtors given the many malpractices that Finance Watch’s research has uncovered in the European credit servicers market, and the problems that can arise from the transfer of a debt from one owner to the other.

Will the precautionary recapitalisation of banks save the day? For the banks being bailed out with public money and benefiting from moral hazard, the answer is clearly “yes” and we can therefore understand their motivation. But for society, which happens to be on the wrong end of the moral hazard game as banks’ losses will be socialised when their profits would have remained private, the answer is clearly “no”.

Overall, Finance Watch supports without ambiguity the preliminary draft opinion written by the EESC, and in particular:

1. When it highlights in its point 3.12 that “it is not credit purchasers and credit servicers who should be supported, but rather it is European businesses, workers and civil society that require resources and full support to withstand the crisis”;
2. But also when it states that we need to provide “tools to address how consumers struggling to pay their bills and make ends meet can survive the pandemic’s effects and avoid sliding into a poverty trap.”

On the issue of financial stability and continuity of bank activity going forward, I have heard two arguments that I am struggling to understand:

1. The first argument is that banks’ balance sheets have to be unencumbered if banks are to be expected to continue lending to the economy. I am not sure I understand the logic here, as it seems to me that you do not need a secondary market to unencumber a balance sheet. You can also, very simply, write-off the loans. It only takes the accountant to make an accounting entry and the trick is done.
2. The second argument is that banks’ capital requirements should be made lighter for NPLs to enable banks to cope with the situation. I have to admit that, here again, I have a great difficulty understanding the argument: prudential regulation is a risk management tool, and the argument seems to be here that the higher the risk the lighter the capital requirements should be. This is slightly counterintuitive, to say the least, unless we take the argument developed by the European Commission in point 2.5 of its December Communication, which explains that lower capital requirements will help banks buy NPLs on the secondary market (that is, therefore, after they have first sold them, I assume). The argument here seems to be that underestimating the NPL risk through lower prudential requirements will help banks trade and speculate on NPLs. This is an interesting concept indeed, albeit one that could be challenged, in particular on the question of its benefit for society.

Conclusion

Please allow me to start my conclusion with an eternal economic truth: markets work to allocate private goods but not public goods. This is basic economic theory. In this instance, the two problems we have to solve are problems related to public goods: financial stability and building a society that does not leave millions on the side of the road.

The good news is that, I order to achieve this double public good objective there is a very simple solution: bail out people, not banks.

Rather than calling on public budgets to bail out banks, make them support the people and businesses that find themselves in a situation where they cannot reimburse their debt. This solution would have two advantages:

1. Firstly, it would remove the loans from the banks’ balance sheets at face value, thereby protecting them from taking the losses that they will take if they sell the loans at a discount in a market. This, in turn, would avoid the need for banks’ recapitalisations.
2. Secondly, it would help individuals and avoid see them dive deeper into the trap of over-indebtedness with all its dire consequences.

Think of it this way:

• For banks, bailing out over-indebted people would bring the same benefit as a recapitalisation when it comes to restoring their balance sheets;
• For the people receiving the bail-out, it would mean avoiding the devastating impact of over-indebtedness;
• For society, it would mean a much better use of public money and avoiding the downside of bank bailouts, not to mention their limited political acceptability.

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