How much do non-performing loans hinder loan growth in Europe?

The severe recessions following the global financial crisis of 2007–2008 left numerous European banks with acutely distressed loan books. In the subsequent recovery, bank lending in Europe has fallen dramatically behind peer advanced economies. This paper focuses on how the post-crisis accumulation of non-performing loans (NPLs) has hindered bank lending in Europe. In assessing the effect of NPLs, we attempt to control for demand factors, simultaneity bias, and the alternative channels through which NPLs affect lending growth. Our primary data source, proprietary quarterly bank-level data from the European Banking Authority (EBA) for 2014–2019, provides detailed information on NPLs for around 200 banks in 30 countries in the European Economic Area. The weak lending growth during the observation period implicates a transmission channel in which NPLs decrease bank profits, increase bank funding costs, and erode bank capital. We find that the strength of the credit squeeze depends on the level of NPLs in the sample. After controlling for this, our estimate of the semi-elasticity of lending growth with respect to NPLs closely matches earlier studies. Given the vital role of bank lending in funding European investment, the possible depressing effect on economic growth from a large NPL burden represents an important policy consideration.