What a Drag: The Burden of Nonperforming Loans on Credit in the Euro Area

By Will Kerry, Jean Portier, Luigi Ruggerone and Constant Verkoren 

High and rising levels of nonperforming loans in the euro area have burdened bank balance sheets and acted as a drag on bank profits. Banks, striving to maintain provisions to cover bad loans, have had fewer earnings to build-up their capital buffers. This combination of weak profits and a decline in the quality of bank assets, resulting in tighter lending standards, has created challenging conditions when it comes to new lending.

We took a closer look at this relationship and the policies to help fix the problem in our latest Global Financial Stability Report because credit is the grease that helps the economy function.

The stock of nonperforming loans has doubled since the start of 2009 and now stands at more than €800 billion for the euro area as whole (see chart). Around 60 percent of these nonperforming loans stem from the corporate loan book.

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Time Not On Our Side: Tough Decisions Needed to Strengthen Financial Stability

As recognized in our Global Financial Stability Report, actions taken by the European Central Bank have helped remove investors’ worst fears. Now policymakers at both the national and euro area level will need to build on these. The stakes are high. For instance, if pressures continue, total assets of major banks in Europe could shrink by as much as $2.8 trillion, possibly leading to a contraction in credit supply in the "periphery" by 9 percent by the end of 2013.

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