The Strategist

Liquidation of European bad debts may take decades

11/07/2016 - 14:17

Volume of overdue loans in portfolios of European banks has reached $ 1.3 trillion. Slow growth of economy and ultra-low interest rates are complicating the bad debts problem of, according to KPMG research company.
Liquidation of the non-performing debts problem may take a few decades, warned analysts of Dutch audit company KPMG. According to their estimates, cited by Bloomberg, current volume of overdue loans in portfolios of European banks has reached € 1,2 trillion ($ 1.3 trillion).

The bad debts issue is complicated with slow growth of the European economy, combined with ultra-low interest rates, explained the company’s experts. In addition, the depressive mood is fueled by changes in banking laws, which, inter alia, stricter capital requirements and increase penalties for violation of regulatory requirements. All this adversely affect profitability of credit institutions.

According to KPMG, share of problem loans in European banks’ portfolios has risen from 1.5% of total loans in 2008 to more than 5% in 2013. That being said, reduction of risky loans will take "decades rather than years".

It is possible to restore profitability of European banks, but the process will be full with difficulties, says KPMG’s partner Marcus Evans. "It is clear that European banks are still adapting to the new era of low or negative interest rates, to growing cost of capital and to new regulatory requirements", - he explained.

According to KPMG, net interest income of European banks is an average of about 1.2%. The same index reaches 3% in the US.

Side effects of low interest rates can aggravate already serious problem of the banking sector’s profitability. Consequently, it will reduce bank reserves and undermine their ability to support growth, warned the International Monetary Fund (IMF) earlier in October.

About a third of European banks with assets of $ 8.5 trillion are now at risk, previously reported the International Monetary Fund. On the other hand, "the US banking system is in a healthy state, despite almost equal share of troubled banks", - the report said.

The IMF believes that European credit institutions need to adapt to sluggish economic growth and low interest rates. In this case, acceleration of the European economy in itself will not a universal key to solve problems of banks. The main issue here is low profitability of the business, the IMF said.

In order to restore the European banking sector, the IMF proposes to optimize the debt repayment procedure by simplifying formalities and reducing timing of obtaining mortgaged property for banks. This will allow the institutions to increase their capital by € 60 billion instead of a € 80 billion-loss, occurred due to write-offs of bad debts.

"In general, implementation of structural reforms would increase profits of European banks by $ 40 billion a year. Taking into account cyclical recovery of the economy, this will enlarge proportion of healthy banks in Europe to 70%", - the IMF said.

According to Stuart Graham, Head of Autonomous research firm, almost all European banks, regardless of their size, are experiencing difficulties with revenues due to low interest rates. The most vulnerable are those involved in traditional business, such as attracting funding from deposits and issuing loans to generate income. Impact of low interest rates is varying from country to country, says Graham, and German and Italian banks are between wind and water. In particular, he estimated that yield on shares of German savings banks will be reduced from the current level of 6.5% to 2% by 2021.