Eurozone banks will get to set their own targets for cutting the 900 billion euros of bad loans left over from the financial crisis, and only sizable shortfalls will be sanctioned, new guidance by the European Central Bank showed on Monday.
The ECB is trying to get banks, particularly in weaker economies such as Italy's, to reduce their burden of soured credit, which is curbing economic growth by curtailing their ability to extend new loans.
Under the new guidance, banks will be asked to set numerical targets for the levels of non-performing loans they aim to reach in one and three years, and follow a number of other guidelines. Failure to do so may lead to "supervisory measures" by the ECB, such as higher capital requirements.
But the ECB said the new guidelines would be non-binding. Only "significant" deviations from the targets may trigger action, and solving the problem would take longer than three years in many cases.
This confirms an earlier Reuters report and suggests the ECB is raising the pressure on banks, rather than forcing their hands, to avoid hitting their profits too hard.
"Part of the engagement is the assessment of whether the banks are close to compliance with the guidance or whether they have very significant gap," said Sharon Donnery, the Irish deputy governor who chaired the ECB's working group on bad loans.
"If there were significant gaps, then obviously we would be discussing with the bank how they would move close toward compliance with the guidance, particularly the time frame over which that was going to happen."
As the euro zone's central bank, the ECB has been trying to revive economic growth and inflation by stimulating lending via ultra-low interest rates and aggressive money printing.
That leaves the ECB walking a thin line between its duties as the euro zone's bank supervisors and its main objective of bringing inflation, currently near zero, to almost two percent.
When the ECB disclosed plans to work on new guidelines for non-performing loans in January, some banks and investors worried that it would force a fire sale of those assets. That would push down their selling price and wipe out the profit of some banks, eating into their capital.
However, the guidelines showed banks will be given three years or, in many cases, longer.
"We chose a three-year target because most banks have a three-year projection in their business plans for a number of banks, this will not be the end of the story, it will likely take longer," Donnery said.
Around 7 percent of all loans on the books of the 129 large banks supervised by the ECB were non-performing at the end of last year, meaning they hadn't been repaid for at least three months, the ECB said in its report.
That ratio rises to 12 percent in Italy, 15 percent in Portugal and 47 percent in Greece. Greek banks and Italy's Monte Paschi have already been handed ambitious targets for reducing their own bad debt.
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