## Debt Hangover: Nonperforming Loans in Europe’s Emerging Economies

_IMF Blog, March 29, 2012_

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**Canonical URL:** [Debt Hangover: Nonperforming Loans in Europe’s Emerging Economies](https://www.imf.org/en/blogs/articles/2012/03/29/debt-hangover-nonperforming-loans-in-europes-emerging-economies)

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## Bibliographic details
- Authors: Christoph Rosenberg, Christoph Klingen
- Published: March 29, 2012

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### Problem overview
- It has been three years since the global economic crisis ended emerging Europe’s credit boom, leaving many loans “sour.”
- Nonperforming loans (many of them household mortgages) have risen sharply, creating problems for banks, credit supply, economic growth, and households.
- The situation is compared to Japan’s lost decade, where a credit boom reversal led to a credit squeeze, declining asset and collateral values, and economic paralysis.

### Key statistics
- Share of loans classified as nonperforming rose from 3 percent before the crisis to 13 percent at the peak.
- Levels in some parts of the Baltics and Balkans are already comparable with previous financial crises elsewhere.

### Findings: impact of nonperforming loans
- Nonperforming loans are a serious drag on credit supply and economic growth.
- Effects on banks:
  - Drive up banks’ funding costs and interest margins.
  - Drain banks’ profits and capital.
- Effects on borrowers and demand:
  - Over-extended households and businesses are reluctant to consume and invest.
- Resolution considerations:
  - Even if NPL resolution brings new losses to the fore, financial stability would not be undermined.
  - Despite the credit boom, the private sector’s debt-to-GDP ratio is still low in most countries, so a resumption of credit growth would not be a problem.

### Obstacles delaying loan resolution
- Collective action problem:
  - Individual banks neglect positive spillovers (for example on collateral values) from resolving loans.
  - Banks are reluctant to book additional losses while facing regulatory and liquidity challenges elsewhere in Europe.
  - “Extend and pretend” behavior: rolling over debt service in hope loans will become performing.
- Structural and institutional constraints:
  - Legal, judicial, tax, and regulatory systems are often poorly equipped to deal with insolvency and to facilitate efficient restructuring.
  - Moving bad loans off banks’ balance sheets, foreclosing, or seizing and selling collateral is difficult in many emerging European countries.

### Policy recommendations and actions
- Collective, country-level push by policymakers, bankers, financial regulators, and supervisors is the preferred approach.
- Banks:
  - Step up the work-out of nonperforming loans, often with help from more experienced Western parent institutions.
  - Writing down unrecoverable loans should not be a taboo.
  - Local banking associations can help overcome first-mover disadvantages.
- Policymakers (country-specific priorities):
  - Create regimes for insolvency and out-of-court restructuring, often from scratch.
  - Design tax regimes that do not punish debt writedowns and loan-loss provisioning.
  - Ensure bankruptcy courts have sufficient resources.
  - Avoid heavy-handed interventions such as extended foreclosure moratoria or mandated debt writedowns, which can undermine payment culture and contractual environment and deter new lending.
- Financial supervisors and regulators:
  - Step up pressure to accelerate resolution of bad loans.
  - Prohibit ever-greening, overvaluation of collateral, and underreporting.
  - Ensure adequate capitalization and provisioning.
  - Remove regulatory obstacles that constrain banks from owning real estate or establishing special vehicles to manage NPLs.
  - Coordinate actions closely between banks’ home and host country regulators.
- International institutions:
  - The IMF, World Bank, the European Bank for Reconstruction and Development, and the European Union can provide international coordination (such as under the Vienna Initiative) and technical assistance.

### Conclusion
- Emerging Europe’s debt hangover will not be cured by a good night’s sleep.
- If policymakers, bankers, supervisors, and international institutions work together, the recovery will be shorter and less painful.

*Source: Debt Hangover: Nonperforming Loans in Europe’s Emerging Economies (Christoph Rosenberg, Christoph Klingen, March 29, 2012).*

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## Content in this bundle

- **030112**
  - [030112 (Markdown version)](/external/region/eur/pdf/2012/030112.pdf.md){rel="alternate" type="text/markdown"}
  - [030112 (PDF)](/external/region/eur/pdf/2012/030112.pdf){rel="external" type="application/pdf"}

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## References

- [lost decade](http://www.imf.org/external/pubs/ft/fandd/2006/06/citrin.htm)
- [Europe](http://www.imf.org/external/region/eur/index.htm)
- [https://www.imf.org/wp-content/uploads/2012/03/npl-ratio.jpg](https://www.imf.org/wp-content/uploads/2012/03/npl-ratio.jpg)
- [emerging Europe](http://www.imf.org/external/pubs/ft/survey/so/2009/INT102809A.htm)
- [International Monetary Fund](http://www.imf.org/external/index.htm)
- [Emerging Europe](http://www.imf.org/external/pubs/ft/survey/so/2010/car102010b.htm)

_Source: https://www.imf.org/en/blogs/articles/2012/03/29/debt-hangover-nonperforming-loans-in-europes-emerging-economies_