A macroeconomic perspective on non-performing loans (NPLs)

This chapter focusses on the observation of high non-performing loans (NPLs) in the current context of a slow economic recovery. High levels of NPLs are a legacy of the crisis and a result of a protracted period of sluggish growth. They reflect the fact that credit risk in the economy is still high. This has an impact on both borrowers' risk aversion and banks' willingness to lend, which result in reduced lending at a time when support to the still modest economic recovery is greatly needed. The macroeconomic significance of NPLs arises from the potential of a vicious circle of low asset quality, low bank profitability, rising capital requirements and constrained lending, with negative effects on growth and a worsening of the initial NPL problems. Through a comparative analysis across groups of EU countries, this section shows that Member tates with high NPL ratios have also experienced below average economic growth, the most visible contractions in bank lending and investment ratios below the EU average. While showing causality is fraught with difficulties (as acknowledged in the analysis), these observations support the expectation of a nexus between NPLs and the contraction in bank lending and investment. Since persistently high NPLs in a number of Member States could be contributing to the currently sluggish nature of the recovery, more rapid progress with NPL resolution could help to break such a vicious circle. In a deeply integrated area like the EU, particularly the euro area, with financial systems highly interconnected, problems with NPLs are likely to negatively impact on credit supply and economic growth not just in the affected Member States but also in the euro area as a whole (though it remains impossible to quantify exactly these channels of cross-border spillovers). These potential broader economic and spillover effects would therefore require not only undertaking important structural measures at Member States level but also, and importantly, a coordinated European approach to the NPL issue, in full respect of the current EU legal framework. This would go a long way in addressing the concerns explained in this analysis. (1)