Dealing with problem banks in a prompt, efficient, and even-handed manner is essential for the European banking union. Much progress has been made, but more needs to be done to strengthen both institutions and practices. We outline the recommendations in this area proposed as part of the IMF’s recent assessment of the euro area financial sector.
Having in place a sound framework and the operational capacity to handle problem banks is critical to “leveling the playing field” in the banking union and to reducing risks. A truly common system is needed to ensure that banks compete on their own merits and are not advantaged or disadvantaged by the jurisdiction where they incorporate. Good supervision—as we’ve seen under the Single Supervisory Mechanism—may reduce the probability of a bank failing abruptly. Yet from time to time banks do fail, so the crisis preparedness and management system needs to be ready to address what might otherwise be costly episodes for governments and economies alike.
Evolving sector
The euro area banking sector constantly evolves, and more consolidation can be expected. In our report, we show that a subset of banks display chronically low profitability, even in good times. In 2016, for example, roughly one in 10 large banks posted very large losses. The weak performers are under pressure to restructure, merge, downsize, or exit—pressure that can only grow with advancing digitalization and competition from nonbanks. Hence, there is going to be a need for a bank recovery and resolution framework that helps make this process as smooth as possible.
Action needed
The Bank Recovery and Resolution Directive and the Single Resolution Mechanism Regulation provide a solid foundation to deal with problem banks. But the framework remains fragmented and contains incentives for member states to resort to national solutions. Therefore, the banking union needs to focus on 5 main areas to be adequately prepared:
Nobody likes a bank failure, but the banking union authorities would be well advised to step up preparations for what, sooner or later, is almost inevitable.