The ECB said it would set expectations for each financial institution on putting aside adequate cash reserves to cover business loans that aren't likely to be repaid on time or in full. Soured loans have been a problem in Europe as they have hindered economic growth and complicated the political efforts to strengthen the setup of the euro.
Banks with large amounts of bad loans are less likely to make new loans, cutting off credit to businesses and restraining growth. Lingering piles of bad loans — most notably in Italy — have also provided ammunition to opponents of deposit insurance at the European Union level. Such deposit insurance would make the eurozone financial system more resistant to panics. But German officials have resisted the proposal, saying risks of bank trouble must first be removed from the system.
The new measure covers banks' pre-existing loans; new loans were addressed by new financial reserve requirements in March. Banks would be expected to bring their coverage of pre-existing bad loans into line with set-asides covering new ones, but without a fixed timeline.
The ECB said banks would be expected to comply over "the medium term," without providing more detail, and their requirements would take into account levels of bad loans at other "comparable" financial institutions.
The ECB said Europe's new system of banking regulation, in which supervision of the most significant banks was transferred to the ECB from national regulators, had already reduced bad loans from 8 percent of outstanding loans in 2014 to 4.9 percent last year.
Nevertheless, the ECB said that the current level of bad loans "remains far too high compared to international standards."