Andrea Enria, chairman of the European Banking Authority, said the trillion euros of bad loans on EU bank balance sheets were a particular burden for medium to smaller sized banks.
Enria, speaking at think tank the Official Monetary and Financial Institutions Forum, said banks that had cleared balance sheets of bad loans were able to lend more.
Finance industry regulators have started to focus more on banks` profitability and ability to lend in a shift away from efforts to ensure the industry is strongly capitalized after the 2007-2009 financial crisis.
Enria said big fines for banks caught breaking rules was another major drag on profitability.
"For a while I have been thinking this is a legacy issue and it will soon go away," Enria said.
"Now, it`s not going away fast enough and I think we need to consider this still as an important element dragging down profitability of banks for some time."
Since the financial crisis, banks have been fined billions of dollars for trying to rig interest rate benchmarks and currency markets.
Regulators have also been trying to get banks to use standardized models to assess the riskiness of the loans on their books rather than use internal risk assessment models.
This has caused alarm among banks because these standard approaches tend to come up with higher amounts of capital that the banks have to hold to support their business.
Enria said there was a role for the banks` own risk models, but regulators were worried by differences in how banks use their models to calculate capital.
"I am more in the camp of those who think we should maintain a significant role for internal models going forward," Enria added. "We should not throw away the baby with the bathwater."
Fines and bad loans big drag on bank profitability: EU watchdog
05 May 2016
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Bad loans and fines for misconduct will hold back European banks` profitability for longer than originally expected, the European Union`s banking watchdog said on Wednesday.
