By John O'Donnell and Balazs Koranyi
FRANKFURT/WASHINGTON (Reuters) - The European Central Bank on Friday rejected criticism of its plans to tackle soured bad debt, arguing that the move was both legal and necessary to resolve a nagging problem that has bogged down banks for a decade.
With support from the International Monetary Fund, ECB bank supervisor Daniele Nouy said the central bank is not creating an additional obligation for banks and the ECB even went beyond the necessary to involve all parties before laying down its proposals.
At the centre of the dispute is how best to tackle European banks' bad loans, which stand at around $1 trillion, a thorny issue, particularly in Italy.
The proposal, which could raise the amount some banks have to set on one side against bad loans, has divided euro zone countries and risked driving a wedge between the ECB and some European Union legislators who believe such proposals are their remit.
Indeed, Roberto Gualtieri, the Italian head of the European Parliament's influential economic affairs committee urged the ECB on Friday to "correct" its stance on bad loans.
Parliament speaker Antonio Tajani, another Italian national, meanwhile told ECB President Mario Draghi he was "deeply concerned" about how the new policies were being set, questioning whether the move fell within the supervisor's mandate.
Nouy responded in a letter saying: "We are of the view that the draft Addendum (on bad debt) falls within the supervisory mandate and powers of the ECB. In fact, it is an obligation of the ECB, in line with its supervisory mandate, to address this key vulnerability in the European banking system."
But Tajani was quick to reject the ECB's response.
"I remain deeply concerned about the fact that specific additional obligations, which may conflict with legislative provisions, can be imposed on supervised entities without appropriately involving the co-legislators in the decision-making process," he said in a reply. Under the proposal, the ECB could force banks to sharply increase provisions on newly classified bad debt. But it would not affect soured debt already sitting on the books.
The problem is that the pile of bad debt weighs on banks' ability to lend, slowing credit growth and undoing the stimulus the ECB's is trying to provide through low rates.
In Washington, International Monetary Fund European department chief Poul Thomsen also defended the proposals, arguing that Italy actually needed the measures to shore up confidence in its bank sector.
"It is by no means a disproportionate measure given that it only pertains to new non-performing loans and not to existing stock," Thomsen told a news conference.
Although often portrayed as chiefly an Italian problem, soured credit affects France and Germany too.
After Italy, which had bad loans of 262 billion euros at the end of March, the biggest pockets of debt not repaid over roughly three months are found consecutively in France, Spain, Greece, Germany and the Netherlands.
The picture alters when measuring the proportion of local loans that are bad. By this yardstick, Greece is worst, where almost one in two loans have not been serviced in three months, according to the European Banking Authority.
This is in good part because of the austerity-fueled recession Greeks suffered in exchange for international bailouts.
Markus Ferber, vice chair of the European Parliament's economic and monetary affairs committee and an influential member of German chancellor Angela Merkel's Christian Democrats party, accused the ECB of overstepping its powers.
"I ... think that the ECB went beyond its mandate and in my opinion that undermines confidence in the work of the ECB as a supervisor," Ferber told Reuters.
"The ECB tried to come up with universal new capital requirements. Such universal rules, however, should be a prerogative of the European legislator."
In Italy and Ireland, roughly one eighth of loans are soured, compared with less than 4 percent in France.
Rating agency Moody's warned that the ECB drive could hurt the credit standing of banks in countries with many problem loans.
"This could cause problems for some firms, especially for those that do not have large capital buffers," said Moody's Alain Laurin.
(Reporting by John O'Donnell and Balazs Koranyi Additional reporting by Francesco Guarascio; Editing by Jeremy Gaunt)