The European Commission has unveiled a proposal that will force the banks operating in the EU area to set aside additional capital to tackle the bad loans problems.

Proposed measures include offloading the existing stock of bad loans, establish new loss-absorbing buffers and support the liquidation of failing lenders.

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The new proposal allows banks and borrowers to agree in advance on an accelerated mechanism to recover the value from loans guaranteed with collateral.

If a borrower defaults, the bank or other secured creditor can recover the loan by liquidating collateral, without approaching court.

However, out-of-court collateral enforcement has been restricted to loans given to businesses. Consumer loans have been excluded.

European Commission vice-president for financial stability, financial services and capital markets union Valdis Dombrovskis said: “As Europe and its economy regain strength, Europe must seize the momentum and accelerate the reduction of NPLs. This is essential to further reduce risks in the European banking sector and strengthen its resilience.

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“With fewer NPLs on their balance sheets, banks will be able to lend more to households and businesses. Our proposals build on the significant risk reduction already achieved in recent years, and must be an integral part of completing the Banking Union through risk reduction and risk sharing.”

EU banks have been focusing to cut down the amount of NPLs on their balance sheets; however, they still account for more than €900bn (nearly $1 trillion) due to which the banks are unable to sanction new loans to companies and households.

Commenting on the proposal, the European Banking Authority (EBA) said that the proposed measures will only have limited impact on capital requirements of banks and should eventually boost their profits.