However, it warned that this would be difficult for non-investment trade countries (such as Cyprus).

The ECB is trying to bring down the amount of non-performing loans at the 127 large banks it supervises, handing out targets to the worst offenders, such as Italy’s Monte Paschi, and setting best practices for the rest.

But the market for bad debt is struggling to take off. The problem is the gap between the price at which banks can afford to sell and what buyers such as private equity funds are prepared to pay.

This is partly because buyers discount the time and cost of working out a bad loan, especially in countries where the judicial system is slow, such as Greece and Italy, and it is sometimes hard for them to value collateral.

Setting up asset-management companies (AMC) – bad banks like those created in Spain and Ireland during the 2008-2012 banking crisis – to buy some of those loans can help ease the pressure on banks and ignite the market, the ECB said.

“Many of the impediments to the creation of secondary NPL markets … can be alleviated by the establishment of a well-designed AMC,” the ECB said in a feature of its Financial Stability Review.

“A further argument for the establishment of an AMC relates to its ability to act as a market reservoir, which can soak up excess NPL stocks while impediments to NPL resolution are being addressed.”

However, it said, “The funding of an AMC, often requiring state guarantees, may be costly and difficult to arrange for non-investment-grade sovereigns. For the state, liabilities (direct or contingent) may be large relative to fiscal headroom.”

The Republic of Cyprus sovereign remains below investment grade.

The Cyprus Minister of Finance, Harris Georgiades, sent a letter to the House of Representatives stressing that bad loans are a matter for banks to solve, not taxpayers. If there is a political decision that taxpayers should contribute (as in the case of the Cooperative Central Bank), this should be done in accordance to the law on State Aid, he said.

The study echoes comments by ECB President Mario Draghi last summer — when the Italian government was negotiating a solution for Monte Paschi with the Commission — which have so far fallen on deaf ears.

Source: InCyprus