Banks that can't lend in crosshairs of European Central Bank as it purges financial system

FRANKFURT, Germany – In Europe, the zombie hunt is on.

Not for undead humans, that is, but zombie banks — the walking dead among lenders, too financially troubled to loan money to an economy that desperately needs investment, growth and jobs.

The European Central Bank, the lead crisis-fighter for the 18 countries that use the euro, is embarking on an extensive search through the books of the biggest banks. It's an arcane exercise — but one whose results will impact people's jobs, businesses and lives. The idea is to restore the system's ability to lend by weeding out lame banks.

Previous efforts in 2009, 2010 and 2011 — by other EU offices with fewer powers — didn't do the job. Some banks passed simulated "stress tests" on paper but needed bailouts soon afterward. So the ECB is putting its reputation on the line.

Together with national regulators and the European Banking Authority, the ECB will first go through thousands of files from 128 of Europe's largest banks to hunt for hidden, soured loans and investments. That will be followed by stress tests that simulate how a bank would fare in a recession or crisis.

Once the verdict is delivered in October, national bank regulators will be asked to push problem banks to raise capital by selling new shares to investors, restricting dividends — or even by being restructured or bailed out. That should help the economy in the long run.

But it's tricky. Forcing banks to fix their problems could temporarily destabilize financial markets and cost investors and governments more money.

"The object is, no more doubts about European banks," said ECB Vice President Vitor Constancio, as he laid out the technical details of the exercise at a news conference Thursday with Daniele Nouy, chair of the ECB's supervisory board.

He said the review would leave bank finances "totally robust and transparent to all investors."

HERE WE GO AGAIN

This is Europe's latest try at sorting out the problems in its banking system left over by the global financial crisis and Europe's ensuing turmoil over government debt. The United States tackled its banking troubles earlier, in 2008-09, pushing banks to take new capital from the government. That helped the U.S. recover from the recession.

At the height of their debt crisis in 2012, European leaders decided to create a centralized supervisor to oversee banks. The idea was to take regulation away from national officials, who can be overly protective of their domestic financial institutions. They gave the job to the ECB, which now needs a clean slate in the banking industry before its supervisory board takes over the function in November.

Asked about the danger that the ECB might take it too easy on the banks, Constancio said, "We will uphold the reputation of the ECB, we will not put it at risk, and we cannot put it at risk."

BROTHER, CAN YOU SPARE A LOAN?

Because so many banks are still in financial trouble, they are not able to lend much to businesses and households. That's preventing the economy from growing and reducing unemployment from a painful 12 percent.

For instance, a bank that has made loans that aren't being repaid may extend the loan or otherwise take it easy on a struggling borrower in hopes they'll eventually pay. But that practice means the bank may not have money to make new loans.

In particular, it is small- and medium-sized companies that can't get the credit they need. Yet it's those companies that provide some 80 percent of the jobs.

Bad loans are a particular target. The ECB and EBA say anything that's more than 90 days overdue will be considered a bad loan — whether the bank has declared it in default or not.

THERE WILL BE BLOOD

ECB President Mario Draghi has said banks "do need to fail" to underline the exercise's credibility.

If a bank can't find more capital from its shareholders, it might have to turn to its government for taxpayers' money. Or, the government itself could turn to the eurozone's taxpayer-backed bailout fund — though political opposition to that is high. The 2011 stress test of 90 banks found eight needed to raise 2.5 billion euros in capital, but noted that banks had scrambled to raise 50 billion euros just ahead of the test.

Analyst Nicolas Veron, who splits his time between Brussels think tank Bruegel and the Peterson Institute for International Economics in Washington, says it's difficult to tell how much capital is needed or how many banks might fail. Some banks have already started raising capital ahead of time.

The ECB test — formally called the asset quality review, or AQR — "is about killing the zombie banks," he said.

"The AQR is there to identify them — and to kill them."