The European Central Bank on Thursday presented new guidelines for how banks should treat bad debt, hoping to prevent a major post-crisis millstone from continuing to lame European lenders.
Its scheme aims to stop new "non-performing loans" (NPLs) where the borrower has fallen behind on repayments sapping bank's balance sheets in future.
"High levels of NPLs affect banks' capital and funding, reduce their profitability, divert resources that could be put to more effective use, and inhibit the supply of credit to households and companies," the ECB said in a statement.
Under the central bank plan, its supervisors would require banks to set aside cash to cover the full amount of loans declared at-risk within two years, if the borrower has not put up collateral to guarantee repayment.
For NPLs covered by collateral, lenders must set aside 40 percent of the value of the debt within two years and the full amount within seven years of their being identified.
The ECB rules are not legally binding, but will guide its supervisors who have been keeping watch over the biggest, most vital banks in the 19-nation eurozone since 2014.
If banks do not comply with the guidelines, set to apply to all newly-identified NPLs from April 1, supervisors could force them to set aside an additional cash buffer to cover potential losses.
- 759 bn euros of bad loans -
Meanwhile, the European Commission on Wednesday offered a scheme to de-fang the existing stock of risky debt.
Already-identified NPLs will not be covered by the new ECB rules and remain a risk for banks.
In the third quarter of 2017, bad debt across the euro area amounted to 759 billion euros ($937 billion), the ECB recalled, down from 950 billion at the start of 2016.
While the EU-wide average level of NPLs is 4.4 percent, different countries have highly variable stocks, from 46.7 percent in Greece or 12.1 percent in Italy to 2.1 percent in Germany.
The European Commission proposals would give banks two years to set aside cash to cover existing NPLs not backed by collateral, and eight to provide for those with guarantees.
"We welcome very much" the Commission plan, Deputy Governor of the Central Bank of Ireland Sharon Donnery said in a telephone conference Thursday, calling it "an important part of the response to NPLs".
It will now be up to the European Parliament and European Union member states to debate the Commission proposals in Brussels, while ECB supervisors can begin applying their guidelines immediately.