larger firms (Iyer et al 2013). Balduzzi et al (2013), in a study of the 2008‐09 US‐led financial crisis and the 2011 sovereign debt crises period, find that, in Italy, higher funding costs for banks meant that young and small client firms faced higher borrowing costs, borrowed less and thus invested less, and hired fewer workers. At the aggregate level, they find that the 2008 crisis, and especially the 2011 crisis, led to sizable reductions in not just the level, but also the allocative efficiency of capital accumulation and employment growth (see also Riley et al, 2015 and Caballero et al, 2008, for the UK). Santos (2011) shows loan spreads increased more for borrowers that were bank‐dependent, than for those that were not dependent on them. Moreover, loans made during the crisis period are larger on average; larger firms, which tend to be safer (they were older firms, had higher interest coverage, lower leverage and higher profits), took these loans.

Delay in resolution has high costs: high NPL ratios tend to constrain the monetary policy transmission mechanism, and credit supply conditions remain tight. The result is low investment and low growth expectations, with the ultimate impact being on employment and/or wages. Policy focus on resolution is needed with more balance in the efforts expended to prevent future crises (when the crisis has already occurred) and more in the speedy resolution of crises‐ especially since prediction (of financial crises) is impossible. Stabilizing large systemic banks is important, yet fast growth recovery is supported by giving attention to, smaller banks, smaller firms and households as well. Macro efforts to stabilize need to be supplemented by customized efforts to deal with distributional impacts which may stymie the macro recovery‐ as evidenced by the extended process of household and firm deleveraging. A new IMF report assessing the constraints to NPL resolution finds that poor supervision, legal obstacles and distressed debt markets are all contributing to slow resolution of problem loans (Aiyar et al, 2015).<sup>71</sup> The study finds that NPL resolution could lead to a substantial increase in loanable funds. In fact, they estimate that as a ratio to GDP, loanable funds could increase as much as 10% of GDP for Greece, and 9% for Ireland. The analysis assumes there is a 5% haircut is due to factors such as the effectiveness of debt enforcement and the rate of return demanded by distressed debt investors, among other things. However, if these costs are very high, the capital relief may end up being negative. Thus, structural reforms are critical to reduce the cost of NPL resolution.<sup>72</sup> _<u>The demand for credit: private sector debt; firm and household perspectives.</u>_ High debt and high NPL ratios have also adversely affected the demand for credit. Over‐indebted firms’ and households’ portfolios worsened as GDP fell and prices fell in the wake of the financial and sovereign crises. In the pre‐ crisis period, all countries had large increases in private debt/GDP ratios as credit growth boomed faster than GDP growth. Around the financial crisis, private debt/GDP ratios peaked even though households and firms were deleveraging. Only in Spain was deleveraging fast enough immediately after 2009 to reduce debt ratios, but by 2011, they were improving for Ireland and Portugal too. Greece, with its large fall in GDP has struggled. Household net debt to disposable income ratios are very high (Table 9), peaking at 241% in Ireland and 154% in Spain. In Greece, this ratio increased three‐fold by 2010 and is now 5 times its level in 2000.The condition of household balance sheets affected the intensity and duration of the macroeconomic impact of the crisis. ECB (2014b) examines household financial conditions and asset price evolution together to analyze how interest rate developments may affect consumption of households. Defining households to be in distress if (a) household income net of taxes, debt payments and basic living costs is negative and (b) debt flow over time is greater than the household’s liquid assets, they find very high levels of household distress in Spain, Greece and Portugal. Deleveraging started earlier among Irish households than among corporations so that the household debt/GDP ratio started declining in early 2010

> 71 They find that in the EU, NPLs stood at over 9% of the region’s GDP at end‐2014, more than double the level of 2009. 72 However, there is great sectoral variation as a third of SMEs (EC 2015) do not have any debt; the construction and retail sector tends to be heavily indebted. As in Spain, household debt levels remain high and deleveraging continues.

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