Banks, non-performing loans and investment

April 12, 2018
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Europe’s banks still have a very large amounts of non-performing loans on their books.  According to some estimates they amount to close to 1000 billion euro.  The problem is particularly acute in Italy, which accounts for about a third of the euro area total. These problems loans are perceived as a big problem. Some have argued that plans to complete the Banking Union must be postponed until the NPLs have been dealt with.  Others have argued that dealing with the NPLs is needed for a sustained recovery, because, so it is often argued, banks will not lend if they have these loans on their balance sheets.  However, this view might be mistaken.

To be sure, it is true that loan growth tends to be weak in economies where the banks have many NPLs on their books.  But this association between NPLs and weak loan growth does not mean that NPLs lead to less credit.  The Japanese case, which is often used to argue that NPLs lead to so-called ‘zombie’ banks, which do not lend, illustrates this point:  once a credit boom ends the banks find themselves naturally with many bad loans.  At the same time, the economy is weak and loan demand is weak.  It is thus natural that one sees high NPLs at the same time as weak lending growth.  The available academic research confirms this point.  It has been very difficult to show that higher NPLs lead to more restrictive credit by banks.  Some have even argued that banks weakened by NPLs might be tempted by the so-called ‘gamble for resurrection’ in which they lend freely in the hope of making up for the losses from the past.

The argument that NPLs are perhaps less important than widely thought applies with particular force to Italy whose growth rate has been falling for almost 20 years now, but investment had actually held up relatively well until the euro crisis hit the country.  The very large NPLs on the books of the Italian banks are thus also due to the fact that investment was too high, for too long.  A large part of the ‘excess investment’ turned then out to have been waste. Given that Italy is supposed to have suffered over the last years from too little investment it might appear strange to argue that too much investment in the previous period is part of the problem today.  But the most recent growth numbers confirm this view:  the growth rate is now finally accelerating, not because investment is booming, but because the banks are becoming more commercial in their lending, which means that the country is getting more out of less investment.

Finally, if one looks carefully at the actual numbers one does not find that productive investment has been stifled in Italy.  For example, if one compares the investment rate in equipment (the key for industrial growth) of Italy to that of France, one finds that in Italy investment in equipment has been consistently higher, about 1 to 2 % of GDP, than that of France (where there was no banking crunch).  However, if one looks at investment in construction a large gap, of about 4 percentage points of GDP has opened up over the last decade.  This implies that the type of investment which industry needs is being finance whereas there is little appetite for building new houses.  A comparison with Germany reveals a similar pattern.  In Italy investment in equipment accounts now for about the same percentage of GDP as in Germany, but construction investment is weaker by about 2 % of GDP.

There are of course countless entrepreneurs who complain that they cannot obtain credit.  This is likely to be true since Italian banks have become more cautious.  But there is little evidence that the tightening in the supply of credit has had a strong impact on equipment investment.


Source: European Commission AMECO database