The main problem facing eurozone banks at the moment is weak profitability rather than solvency, European Central Bank chief Mario Draghi said on Thursday amid concerns that a new banking crisis could be brewing.
He also suggested that public money should be used to backstop the banks in “exceptional circumstances.”
“On the solvency side, our banks are better, if not much better than they were before,” Draghi told a regular news conference, adding: “The problem now that we will have to address is the weak profitability ahead, not a problem of solvency.”
The European Banking Authority will next week publish the results of a new set of stress tests, in which 37 eurozone banks took part.
Italian financial market worries
Fears are rife on the financial markets that Italy, in particular, could cause a return of the eurozone debt crisis if it does not address the 360 billion euros in bad debt sitting in its national banks.
Markets have turned sour on several Italian banks, most notably Italy’s number-three lender and the world’s oldest bank, Banca Monte Paschi.
But banks are generally in much better shape than in 2009 and have substantially strengthened their capital buffers, Draghi said.
Their average core capital ratio–the amount of funds they can call upon to absorb losses–has increased from around nine percent to 15 percent, thanks to robust supervisory systems and regulations that have since been put in place.
Nevertheless, bad debt, or so-called non-performing loans (NPLs), posed a “significant problem for the future ability and the capacity the banks have of lending,” Draghi said.
Weakness of credit activity
The chronic weakness of credit activity in the euro area has previously been blamed for the absence of any noticeable recovery in the 19 countries that share the single currency.
“It’s a problem that needs to be addressed because it’s an obstacle to the transmission of monetary policy,” Draghi said.
To help address the problem, there should be “a public backstop when in times of exceptional circumstances the NPL market is not functioning,” Draghi said, adding: “A public backstop is a measure that would be very useful, but certainly should be agreed with the EU Commission according to the existing rules.”
Italy has been seeking to use public money to help shore up banks without forcing private investors to accept some losses as EU rules require as many small retail savers bought bank debt, fearful of a public backlash that could scuttle an upcoming referendum on political reforms.