ECB asks banks to set aside more cash for bad debt amid €1tn problem

Central bank attempts to prevent creation of new eurozone debt pile by making it more expensive to hold problem loans.

The European Central Bank is attempting to put a lid on the near €1tn (£886m) of bad debts stored up in eurozone banks by asking lenders to be more prudent about the way they handle new customers falling behind on repayments.

The Frankfurt-based central bank issued new guidance on Wednesday intended to stop a new pile of problem debts being built up inside eurozone banks by setting out how much cash it wants lenders to set aside for bad debts incurred from January 2018.

The measures are not applicable to the existing €1tn of bad debts, which are largely a legacy of Europe’s financial problems in the aftermath of the 2008 crash and languishing on the balance sheets of banks in countries such as Greece, Cyprus and Italy.

The ECB wants lenders to set aside 100% of the value of an unsecured loan within two years and gives lenders seven years to put aside the full amount of a secured loan, such as a mortgage.

The aim is to set a formal guideline for how to tackle problem loans – known as non-performing loans (NPLs) – in contrast to the current situation where there are a variety of approaches across eurozone countries.

Policymakers are concerned that bad debts inside banks not only weaken lenders but also make it difficult for them to grant more loans, which in turn can impede economic growth. But they are sensitive to announcing new measures that would make banks more cautious about issuing new loans or push up the cost of borrowing.

Sharon Donnery, deputy governor of the Central Bank of Ireland who presented the latest plan by the ECB to tackle bad debts, said: “We want to prevent a build-up of insufficiently covered NPLs in the future.”

The new measures are not applicable to the existing stock of bad debts for which lenders have set aside 45% of the value of their problem loans, so if the new rules had been applied it could have led to multibillion-euro provisions for lenders.

The ECB announced measures in March intended to tackle the existing bad debts, including requiring lenders to set up dedicated teams to handle troubled customers in so-called work-out units and put the onus on management to sort out the problem.

The new proposals will be open for consultation until 8 December and are not binding on the lenders, which will be required to explain if they do not meet the rules.