IMF Blog IMF Blog

What a Drag: The Burden of Nonperforming Loans on Credit in the Euro Area

High and rising levels of nonperforming loans in the euro area have burdened bank balance sheets and acted as a drag on bank profits. Banks, striving to maintain provisions to cover bad loans, have had fewer earnings to build-up their capital buffers. This combination of weak profits and a decline in the quality of bank assets, resulting in tighter lending standards, has created challenging conditions when it comes to new lending.

We took a closer look at this relationship and the policies to help fix the problem in our latest Global Financial Stability Report because credit is the grease that helps the economy function.

The stock of nonperforming loans has doubled since the start of 2009 and now stands at more than €800 billion for the euro area as whole (see chart). Around 60 percent of these nonperforming loans stem from the corporate loan book.

NPLs chart

Resolution of nonperforming loans 

There is a need to resolve this large stock of nonperforming loans clogging bank balance sheets. But there has not been much progress to date. The stock of nonperforming loans continues to rise, albeit at a slower pace than before, and banks have sold less than 6 % of the stock of nonperforming loans. Resolution has been hampered by three key factors.

Cleanup of bank balance sheets 

Policymakers and banks have two other avenues they should pursue.

First, banks need to clean up their balance sheets. The ongoing assessment of banks, conducted by the European Central Bank and the European Banking Authority is a first step in this process. The assessment needs to be credible, reliable and transparent, and should be followed by remedial actions that are implemented on a timely basis and clearly communicated to the market.

In parallel, further actions are needed to fully address the constraints impeding the resolution of nonperforming assets:

New sources of credit 

Along with measures to facilitate an increase in corporate equity levels, including via targeted measures to encourage debt-for-equity swaps, authorities and markets could develop nonbank sources of credit, including bonds, further. However, officials need to ensure that effective regulation and supervision of nonbank entities should accompany these efforts to avoid building future problems.

Euro area policymakers face a daunting task in addressing the legacy debt burden to help complete the transition to an integrated financial system. Without significant policy efforts to address the burden of nonperforming loans, some economies may find they remain stuck in the mire of low profitability, low credit and low growth.