Asset management companies stabilize credit by breaking NPL feedback loop
A new European Central Bank working paper finds that asset management companies (AMCs) effectively stabilize credit by purchasing nonperforming loans (NPLs) and breaking the feedback loop between default rates and lending costs. The study, calibrated to the eurozone, shows AMCs reduce default rates and lower lending costs, unlike government purchases of performing loans.
Breaking the vicious cycle of default
Asset management companies (AMCs) effectively break the detrimental feedback loop between elevated default rates and increased lending costs.
By purchasing nonperforming loans (NPLs) at their long-run recovery values, AMCs fix the effective default rate that banks face, enabling them to offer lower interest rates on new loans.
This mechanism reduces debt servicing burdens for borrowers, leading to fewer defaults and reversing the vicious cycle.
Calibrated to the eurozone, the model shows an active AMC reduces quarterly default rates by 0.8 percentage points and lowers lending rates by 1.6 percentage points, ultimately raising welfare by 0.2 percent of permanent consumption.
In contrast, government purchases of performing loans, while expanding credit, fail to address this feedback.
Such purchases crowd out bank deposits, contracting overall credit supply, leading to an increase in default rates by 1.8 percentage points and a rise in lending rates by 1.2 percentage points.
Addressing market failures in distressed debt
Between 2014 and 2018, nearly 10 percent of loans held by European banks were nonperforming, constraining bank profitability and lending growth.
This was due to a feedback loop where high default rates forced banks to increase lending costs, which in turn led to more defaults.
Several European governments responded by establishing AMCs, such as Ireland's National Asset Management Agency (44% of GDP) and similar entities in Spain and Slovenia (10-16% of GDP).
These AMCs address critical market failures in distressed debt, including information asymmetry, an oligopsonistic market structure, and legal barriers impeding claim enforcement.
By mitigating these frictions, AMCs can catalyze private market development for impaired assets.
A targeted solution for financial stability
This study provides crucial quantitative evidence supporting the effectiveness of asset management companies in stabilizing credit.
It clearly distinguishes between targeted NPL interventions and broader government asset purchases, highlighting the former's unique ability to break the default-lending rate feedback loop.
The findings underscore that AMCs are not merely a temporary fix but an essential, strategically valuable tool for policymakers addressing financial stability challenges.