Non-performing Loans (NPLs)
The financial crisis and ensuing recessions as well as structural factors and inadequate loan origination practices have resulted in high levels of non-performing loans (NPLs)* in Europe in comparison to other leading economies. For example, in 2016, the ratio of bank NPLs to total gross loans in the EU was 4.4% compared to 1.3% in the USA. The problem is particularly acute in some member states: ten individual EU member states had NPL ratios of over 10% (in Greece, as high as 45.9%). The situation imposes risks to their own financial systems and economies that could spill over to other states.
Although individual banks are primarily responsible for restructuring their business models and resolving their NPLs, the Economic and Financial Affairs Council recognised that measures to reduce the existing stock of NPLs and to prevent their future emergence would benefit the EU economy and financial stability overall and thus agreed upon an Action Plan to tackle NPLs in Europe on 11 July 2017, in response to the Report of the Financial Services Committee Subgroup on NPLs from 31 May 2017. The Council’s action plan stresses a comprehensive approach covering different policy areas: (i) supervision, (ii) structural reforms of insolvency and debt recovery frameworks, (iii) development of secondary markets for distressed assets, and (iv) fostering restructuring of the banking system. It distributes 14 tasks to the European Commission, the European Central Bank (ECB), the European Banking Authority (EBA), the European Systemic Risk Board and member states.
Some of the tasks centre on insolvency, loan enforcement regimes and macro-prudential approaches to prevent system-wide NPL problems; however, considering potential, future, supervisory requirements for banks, one can classify the tasks into four broad categories.
In March 2017, the ECB published its Guidance to banks on NPLs, a supervisory tool aimed at significant institutions to clarify expectations regarding NPL identification, management, measurement and write-offs in areas where existing regulations, directives or guidelines are unspecific and which urges a timely convergence of regulatory and accounting views where those differ substantially.
The Council urged national competent authorities to implement an adapted ECB Guidance by the end of 2018 for less significant institutions. It called on banks to implement realistic and ambitious strategies to work towards a holistic approach to the problem of NPLs, including areas such as governance and risk management, for example, ensuring that managers are motivated to carry out NPL-reduction strategies under the scrutiny of their management bodies.
Additionally, the EBA was invited to produce guidelines (GL) applying to all banks in the EU, which the EBA published on 31 October 2018: GL on the management of non-performing and forborne exposures (NPEs & FBEs).** The GL would apply from the 1 January 2019, setting out requirements on processes to recognise NPEs and FBEs, as well as a forbearance-granting process with a focus on the viability of forbearance measures. Another EBA GL, on loan origination, monitoring & internal governance, is not expected to be finalised until Q1 2019.
The ECB Guidance was followed up in March 2018 by the finalised Addendum to the ECB Guidance to banks on NPLs: Prudential provisioning backstop for NPEs, which demands full coverage for the unsecured portion of new NPLs. The addendum is non-binding but will serve as the basis for the supervisory dialogue between significant banks and ECB Banking Supervision. The result of this dialogue will be incorporated, for the first time, in the 2021 Supervisory Review and Evaluation Process (SREP).
The action plan called upon the EC to issue an interpretation of existing supervisory powers regarding banks’ provisioning policies as laid out in the Single Supervisory Mechanism Regulation and the Capital Requirement Directive and within the framework of the ongoing review of the Capital Requirements Regulation & Directive (CRR/CRD IV). The EC launched a consultation on 10 July 2017 to gather stakeholders’ views on the possible introduction of statutory prudential backstops addressing insufficient provisioning for newly originated loans that turn non-performing, as well as on the potential functioning, scope, design and calibration of such prudential backstops. According to the action plan and within the framework of ongoing review of the CRR/CRD IV, these statutory backstops could take the shape of compulsory prudential deductions from own funds of NPLs, following an assessment of the most appropriate calibrations in line with international practice. In its Single Supervisory Mechanism Review Report, accompanying the Communication from October 2017, the EC confirmed that the supervisory powers enshrined therein allow the competent authorities to influence a bank's provisioning policy with regard to NPLs within the limits of the applicable accounting framework and to apply specific adjustments where necessary for prudential purposes.
In November 2017, the EC called to the EBA for advice. The EBA answered on 14 March 2018 with a report on prudential backstops, supporting compulsory deductions from regulatory capital. In March 2018, the EC released a package of measures, which included a proposal for a regulation amending the CRR as regards minimum loss coverage for NPEs.
Furthermore, the EC, as well as the European Parliament and the Council clarified transitional arrangements for mitigating the impact on own funds of the introduction of International Financial Accounting Standards 9 (IFRS 9) with Regulation (EU) 2017/2395. Banks have had to adjust their financial reporting accordingly. Although related, the accounting and regulatory definition of default still vary.
The action plan invited the EBA to enhance disclosure requirements on asset quality and NPLs in consultation with the European Securities and Markets Authority (ESMA). On 27 April 2018, the EBA launched a consultation on draft GL on disclosure of NPEs and FBEs which includes ten disclosure templates for use from 31 December 2019. The GL apply to credit institutions that are subject to all or part of the disclosure requirements specified in the CRR. Four of the templates are applicable to all credit institutions and six apply only to significant institutions with high levels of NPLs.
Lastly, one of the tasks from the action plan was, for the EC, to issue a blueprint on the set-up of national asset management companies (AMCs), which it published on 8 March 2018. The non-binding blueprint provides practical guidance for the design and set-up of AMCs by one or more banks or by public authorities. Furthermore, the EC needs to develop, by summer 2018, a European approach to NPL secondary markets, enabling the transfer of NPLs by banks to non-banks and simplifying licensing for third-party loan servicers. Included in the package of measures on NPLs proposed by the EC in March 2018, was a proposal for a directive on credit servicers, credit purchasers and the recovery of collateral.
The EBA, ECB and EC were called upon to strengthen data infrastructure with standardised data to facilitate disposal of NPLs and to consider setting up NPL transaction platforms and the EBA to issue GL on loan tapes monitoring, specifying minimal detailed information required from banks on their credit exposures in the banking book. The EBA published EBA NPL disclosure templates for secondary-market disposal on 14 December 2017, which are completely voluntary for banks and which were the subjection of a test collection from February to June 2018 by European DataWarehouse.
* These are bank loans that are more than 90 days past due and/or for which the debtor is assessed as unlikely to repay in full without realisation of collateral, regardless of the existence of any past-due amount or of the number of days past due.
** Strictly speaking the term NPL applies only to on-balance sheet loans and other amounts due (e.g. interest and fees), while the term NPE includes, in addition, off-balance sheet items, such as, loan commitments and financial guarantees. However, the ECB uses the terms synonymously to mean NPE.