They gather in dark corners. They haunt the living. They are zombies – and central banks are afraid of them.
Central banks worry about zombie companies ‘buried’ in the balance sheets of banks. That is why new legislation was brought in by the EU in 2018 to demand “minimum loss coverage for non-performing loans”.
A zombie company, according to the Bank for International Settlements, is one that can’t meet the costs of servicing its debts over an extended period.
Many companies can have temporary cash-flow problems, and many growing companies don’t make much money at first, but a zombie is one that will never be profitable. The Bank for International Settlements is concerned that low interest rates are helping to create more zombies and keeping them alive.
What central banks dread about the zombies is their deadening effect on economic performance. Banks should support economic growth by lending capital to productive companies. When they have zombies on their balance sheet, the money goes to firms that are more dead than alive.
And, when bank balance sheets have too many bad loans, they stop lending to good companies. The health of the bank itself can also be threatened.
‘Non-performing loans’ (NPLs) is the polite phrase for a loan that is a burden on the bank that made it. The EU defines NPLs as loans that are “more than 90 days past due, or…unlikely to be fully repaid”.
Bad loans can always be a problem for banks, but NPLs became a significant issue in some European countries after the financial crisis of 2007–08. This was partly because more companies were struggling, and partly because funding regulations were changed to boost bank resilience.
In particular, European banks now have to have much more equity funding. This is more expensive than debt funding, but it makes banks more stable because it does not have to be paid back if something goes wrong.
The European Commission said in June 2019 that the average Tier 1 capital of banks was just over 15% in Q4 2018. The banks also hold more liquid assets and are less highly leveraged. Systemically important banks have also raised debt that converts into equity if they get into trouble.
However, banks with NPLs also have to raise more regulatory capital to cover those potential losses – and to pay more for in the markets for liquidity. That makes them less profitable and stymies growth.
Taken together, raising equity funding and covering the costs of having more NPLs can be a heavy burden.
NPLs – a threat at the periphery?
Some banks in some EU countries with lots of NPLs look more dead than alive. In Greece, in particular, over 47% of private sector loans were non-performing in Q3 2018. In Germany, that number was 2.6%. German banks had made provisions to cover 85% of the bad, or questionable, loans on their books. Greek banks, however, had made provisions for just 51% of doubtful loans and NPLs.
In a speech to the Bank for International Settlements, Yannis Stournaras, Governor of the Central Bank of Greece called in September 2019 for a “truly systemic solution, something like an asset management company”, to deal more quickly with the NPLs in Greece.
He warned that “unless NPLs are removed from bank balance sheets very quickly, Greek banks will not be able to generate enough capital internally”. Since Greek banks with lots of NPLs are unlikely to attract investors, that could mean trouble for the Greek banking sector.
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