Abstract
Economic recovery and a more intrusive supervision have contributed to the progress recently made in reducing the NPL (non-performing loan) legacy in the most affected euro area countries. However, ample differences exist in the adjustment path, explained by country-specific factors and fragilities, and by different constraints arising from the new regulatory framework of bank crisis management. Due to the NPL overhang, many European banks are still in vulnerable conditions, although formally compliant with capital requirements. The single supervisory rulebook has remained unfinished lacking a harmonised supervisory treatment of NPLs. The prudential provisioning backstop proposed by the European Commission in the context of its NPL package is therefore a significant regulatory innovation, aimed at defining a consistent relationship between bank capital and loan loss reserves. However, not enough attention has be paid to what really ought to be the main purpose in dealing with the NPL legacy, that is, maximising the number and the amount of problem loans returned to the performing status.
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Notes
- 1.
The ECB statistical database defines as large those banks whose assets as a percentage of total consolidated assets of EU banks are greater than 0.5%, medium-sized those between 0.5% and 0.005%, small those with less than 0.005%.
- 2.
One example is Germany, where relevant pockets of vulnerability characterise the sector of Landesbanken. For many of these regional public banks the severity of the NPL problem is no less serious than that in more vulnerable countries. This is due to their great exposure to the distressed shipping sector and foreign commercial real estate (IMF 2014a, p. 66).
- 3.
Loan loss reserves (also called loan loss allowances) absorb future losses both from problem loans and from apparently performing loans, which would later turn into non-performing status. These reserves are established and increased by provisions for loan losses, which are periodic charges against earnings.
- 4.
According to Laeven and Valencia (2012, 2018), from 2008 to 2017, these countries were hit by a banking crisis, defined as “systemic” for Cyprus, Greece, Ireland and Spain, and “borderline” for Italy, Portugal and Slovenia. ESRB (ESRB 2017b) defines as “systemic” the banking crises experienced by all these countries, starting already in 2008–2009 in Ireland, Spain and Portugal, and between late 2009 and 2011 in Greece, Italy, Cyprus and Slovenia.
- 5.
The recapitalisation of banks was indirect, because EU funds were provided to a public agency, the Fund for the Orderly Restructuration of the Banking System (FROB), created in 2009, at the start of crisis, which utilised them mainly to remove NPLs from banks’ balance sheets through the new created asset management company (SAREB).
- 6.
Strict provisioning rules on vintage NPLs and foreclosures had been issued in 2012, thanks to the fact that, the only case in Europa, Banco de España, the national supervisory authority, is also an accounting regulator (ECB 2017a, p. 125). Banks had been obliged to calculate provisions over the unsecured portion of loans according to supervisory minimum ratios, defined as in a range from 25% after three months and 100% after 21 months. The objective was to encourage banks to reduce their NPLs by selling them on the market or transferring to SAREB (Banco de España 2017, p. 114).
- 7.
Communication from the Commission on the application, from August 2013, of State aid rules to support measures in favour of banks in the context of the financial crisis (“Banking Communication”), 2013/C 216/01. These measures are considered state aid because they include the transfer of NPLs to an asset management company with transfer prices generally above market price: state aid consists therefore in reducing losses borne by banks to the difference between book value and transfer price of NPLs.
- 8.
NPL crises in the affected countries have been not only the consequences of macroeconomic factors (the double-dip recession), but also of mismanagement and supervisory failures. An example is Spain, whose crisis was a combination of a real estate bubble and burst, excessive growth of private indebtedness and macroscopic failures of bank supervisors. Indeed, they largely under-valuated the risks of an abnormal increase and concentration in bank portfolios of mortgages and real estate developer loans, and the governance issues associated to the political control of the saving banks (the cajas) (Garricano 2012).
- 9.
This indicator is a simplified version of the Texas ratio, calculated by dividing gross NPLs by the sum of loan loss reserves and tangible capital. Like Texas ratio, it “provides a link between NPL exposures and capital level” (ECB 2017b, p. 30). It is much more useful than the simple NPL ratio for evaluating the effects that NPLs may have on bank vulnerability, because it takes into account the amount of problem loans and the resources (capital and reserves for loan losses) available to absorb their expected and unexpected losses.
- 10.
These problems have been only partially addressed by the 2014 Mortgage Credit Directive (Directive 2014/17/EU of the European Parliament and of the Council of 4 February 2014 on credit agreements for consumer relating immovable property and amending Directives 2008/48/EC and 2013/36/EU and Regulation (EU) No 1093/2010). Between 2010 and 2012, new provisions for debt discharge of over-indebted households were introduced in Ireland, Greece, Italy and Spain (Bouyon and Musmeci 2016).
- 11.
This is empirically confirmed by the large bid-ask spreads (the difference between the prices investors are available to pay for NPLs in the secondary markets and the prices at which banks are prepared to sell them) estimated for Italy, where recovery costs are among the highest in Europe (Fell et al. 2017, p. 133; Garrido et al. 2016).
- 12.
Write-offs occur when loans are reasonably deemed unrecoverable (partially or in full) and are therefore removed from the bank books together with the corresponding loan loss reserve. This asset derecognition always results from granting distressed borrowers forbearance measures aimed at debt restructuring, even if it does not entail a renouncement of the bank’s legal right to recover forborne loans (ECB 2017b, p. 80). Write-offs of loans already provisioned are offset by the reduction of loan loss allowances, while unanticipated write-offs directly impact upon bank profits and capital.
- 13.
This is the economic background of the Basel capital framework, which however applies in full only under the IRB approach. Under the standardised approach, the concept of default is utilised for allocating loans in the class of defaulted exposures, to be covered with capital for the value net of specific loan loss reserves, with risk-weights increasing from 100% to 150% for NPLs that are not adequately provisioned.
- 14.
Under the new standard, banks must allocate all credit exposures into one of the three “Stage”, and this determines how impairment is calculated. While in “Stage 1”, low risk exposures are allocated, in “Stage 2” exposures with a significant increase of credit risk are included, and in “Stage 3” defaulted exposures or exposures for which a loss event has already incurred.
- 15.
Commission Implementing Regulation (EU) 680/2014 of 16 April 2014, amended by Commission Implementing Regulation (EU) 227/2015 of 9 January 2015, laying down implementing technical standards with regards to supervisory reporting of institutions according to Regulation (EU) 575/2013 of the European Parliament and of the Council.
- 16.
The negative effects of bank forbearance practices on transparency and accuracy of information disclosed to markets by financial statements were also stressed by ESMA, which highlighted that “[f]orbearance should not lead to avoiding or postponing the recognition of impairment or obscuring the level of credit risk resulting for forborne assets.” (ESMA 2012, p. 1).
- 17.
Regulation (EU) No. 575/2013 of the European Parliament and of the Council of 26 June 2013.
- 18.
The EBA’s standard covers “non-performing exposures”, which include not only loans, but also debt securities of the banking book, financial guarantees and loan commitments given (off-balance-sheet items). Foreclosed assets are not included.
- 19.
The debtor approach for retail exposures, when a significant threshold is classified as non-performing, generates one of the main divergences between non-performing, defaulted and impaired loans. The other arises from the rules prescribed for forborne non-performing loans to be upgraded to the performing status. EBA calculated that, in average, the NPL ratio was higher than default ratio (Defaulted loans and advances/Total loans and advances) about 0.30 pp., as of March 2016 (EBA 2016).
- 20.
The EBA ITS classification of non-performing exposures and forbearance is substantially aligned with the one proposed in the BCBS’s guidelines for prudential treatment of problem loans (BCBS 2017a), even if the BCBS conditions for forborne status exit are milder (for instance, the required probation period is only one year).
- 21.
Even if the EBA ITS is binding for supervisory reporting, some significant divergences remain between NPLs values reported in the supervisory statistics by ECB and national authorities. An example can be seen in Slovenia, whose NPL ratios in the years 2015–2017, according to IMF Financial Soundness Indicators (data submitted by national supervisors) are much lower than the ECB’s ones: at the end 2017, 3.2% against 9.18%. This is because the Bank of Slovenia (the Slovenian supervisory authority) submitted to the IMF non-consolidated data for NPLs, that is, excluding foreign subsidiaries of domestic banks (Bank of Slovenia 2018, p. 28).
- 22.
The cure rate is the percentage of previously non-performing loans which, after restructuring, are classified as performing.
- 23.
- 24.
See, accordingly, Article 178(3), points (e) and (f) of the CRR.
- 25.
Commission Recommendation of 12 March 2014 on a new approach to business failure and insolvency, 2014/135/EU. Two years later, the Commission released a proposal of a Directive aimed at establishing a harmonised judicial framework on preventive restructuring and debt discharge for companies and entrepreneurs (Proposal for a Directive of the European Parliament and of the Council on preventive restructuring frameworks, second chance and measures to increase the efficiency of restructuring, insolvency and discharge procedure and amending Directive 2012/30/EU, COM/2016/0723 final, 22.11.2016).
- 26.
The Guidance (and the Addendum) was prepared by the High-Level Group on NPLs, established within the SSM in July 2015 and composed by representatives of the national competent authorities and the ECB.
- 27.
At the European level, it is the ESMA which is responsible to promote the consistent application of IFRS and foster convergence of enforcement practices.
- 28.
However, according to the EU rules, the application of the IFRS is only compulsory for listed banks in their consolidated financial statements. Therefore, for individual banks, different accounting standards have been established in the various European countries. For instance, in Germany, all not listed banks have been allowed to remain on national generally accepted accounting principles (GAAP).
- 29.
The expected increase of provisions under IFRS 9 will mainly arise from the higher impairment, which must be reported for the forborne exposures classified in the “Stage 2”. For IRB portfolios, the impact on Common Equity Tier 1 capital (CET1) will be a reduction of available own funds, partially offset by a reduction of the capital shortfall. For exposures under the standardised approach, major provisioning will reduce the denominator of the solvency ratios (risk-weighted assets), which therefore decrease less than the available own funds.
- 30.
Transitional arrangements for mitigating the impact on regulatory capital from the application of expected credit loss accounting have been introduced into Basel framework by the Basel Committee (BCBS 2017b). Single jurisdiction is allowed wide discretion in implementing this option, which anyway must apply to only “new” provisions, that is, not to provisions which would exist under the incurred loss approach. According to Regulation (EU) 2017/2395 of the European Parliament and the Council of 12 December 2017, banks can dilute the reduction of own funds due to the increase of provisions resulting from IFRS 9, adding back these major provisions to their capital in a decreasing amount over five years.
- 31.
However, the convenience of the sale option under the phase-in regime can be offset by the fact that the resulting major losses will be reflected in the dataset used for the estimates of the rate of recovery (LGD), therefore increasing capital requirements.
- 32.
Prudential filters are adjustments made in regulatory capital calculation that address the impact of accounting values which are considered undesirable from a prudential perspective for preserving the quality of capital.
- 33.
On this matter, supervisory powers come from the Article 104(1)(d) of the CRD and 16(2)(b) of the SSM Regulation. The wording of the two articles is the same: the supervisory authority shall have at least the following powers: “…to require institutions to apply a specific provisioning policy or treatment of assets in terms of own funds requirements”.
- 34.
The other measures proposed by the Commission for implementing the 2017 Council Action on NPLs are a Directive on credit servicers, credit purchasers and the recovery of collateral, aimed at fostering the development of secondary markets for NPLs and facilitating out-of-court collateral enforcement for loans granted to business; and a European blueprint providing non-binding guidance for the design and set-up of Asset management Companies at a national level in compliance with banking and state aid rules (European Commission 2018a).
- 35.
Credit servicers act as intermediaries on behalf of NPL purchasers, collecting payments from sold debtors. NPL purchasers are specialised funds, often labelled with the derogatory term of “vulture funds”.
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Montanaro, E. (2019). Non-Performing Loans and the European Union Legal Framework. In: Chiti, M.P., Santoro, V. (eds) The Palgrave Handbook of European Banking Union Law. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-13475-4_10
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DOI: https://doi.org/10.1007/978-3-030-13475-4_10
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