EU Sees Taxpayers Funding Bank Bad-Loan Fix Within Current Rules

European Union member states can use public funds to help struggling banks dispose of soured loans, but only within the limits of laws put in place since the financial crisis, according to an EU report.

While EU law normally stipulates that the need for “extraordinary public financial support” means a bank is failing and should be wound down, an exception is made for temporary state aid, known as a precautionary recapitalization, to address a capital shortfall identified in a stress test. “It seems conceivable” for governments to use such aid to finance an impaired-asset measure, the May 31 report states.

The document says the conditions in EU law for giving state aid to a solvent bank must be observed. “Dealing with the issue of high NPLs should not imply any deviation from the rules of the banking union,” it states, referring to the package of laws intended to bolster financial stability and deepen integration in the bloc.

Andrea Enria, head of the European Banking Authority, has been one of the most vocal proponents of allowing state aid for banks that incur losses in the course of selling bad loans. He told EU lawmakers in April that state aid could be used to “deal promptly and decisively with the significant legacy of asset-quality problems in the European banking sector, which remains a drag on the EU economy.”

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Freeing up public money to offset banks’ losses could help to chip away at the 1 trillion-euro ($1.1 trillion) bad-debt mountain and could smooth the way for bailouts in the EU’s hardest-hit countries, including Cyprus, Portugal and Italy.

Monte Paschi

Italy is negotiating the terms of a precautionary recapitalization for Banca Monte dei Paschi di Siena SpA, which is trying to offload about 30 billion euros of bad loans through a securitization. Monte Paschi will “dispose of its entire nonperforming loans portfolio on market terms,” the European Commission said on June 1.

The report, prepared by representatives of the European Commission, EU member states and several financial supervisors, also outlines measures to improve secondary markets for nonperforming loans, reform national insolvency frameworks and enhance the supervision of banks’ bad assets.