Non-Performing Loans (NPLs) are a key issue and will continue to be on the European agenda as a top priority for a long time.
On the one hand, the ECB guidelines are already applicable, as they represent a best practice reference for the day-by-day work of the Joint Supervisory Teams. On the other hand, the high level of NPLs sitting on the balance sheet of banks operating in countries most affected by the financial crisis, coupled with the limited size of sales observed in the market, suggests that what the ECB calls an “extraordinary situation” is, in effect, going to remain until a sustainable reduction is finally achieved.
From a micro perspective, compliance with the guidelines may imply a broad range of remediation activities, the relevance of which vary according to the degree of severity of the specific weaknesses of each concerned bank. Engaging in a self-assessment is clearly the first step. Immediate applicability of the ECB guidelines means, to say the least, that every concerned bank has to identify its specific areas of improvement and build an appropriate remediation plan. Actions may affect end-to-end credit processes ranging from governance to operations, remuneration schemes, data quality and IT integration, as well as provisioning and reporting. In parallel to the operational layer, strategic implications include changes in credit granting and forbearance policies, review or even externalization of servicing activities and disposal of selected portfolios.
As a result, and depending on the severity of the situation, a transition period and disciplined planning is necessary. In order to turn an issue into an opportunity and, most importantly, avoid unintended consequences of interlinks existing between different regulations, the systematic research of synergies with IFRS 9 implementation projects is encouraged so that capital and strategic implications, as well as target operating model transformation, may take both into account. For example, automatization of recovery actions in the early arrears phase may provide a presumption of increased credit risk and, for accounting purposes, of long-life expected loss provisioning. At the same time, integrating external data such as credit registers, researches, etc., into the back office early warning engine is in line with incorporating forward-looking information into the accounting classification.
From a macro perspective, the stocktaking document accompanying the ECB guidance clearly identifies several areas of intervention by national legislation, in order to remove the relevant remaining differences in bankruptcy legislations and judicial and extrajudicial practices, before defining a fully harmonized quantitative target ratio for NPLs across Europe. Such national legislation work will necessarily take time to be completed. In the meanwhile, in pursuing the goal of achieving an ambitious and sustainable target of reduction in NPL volumes, it is to up to each bank to engage in a constructive dialogue with its respective supervisory teams in order to appropriately frame contingent situations and local specificities and demonstrate why they think that their strategy is reasonable. Further developments may also come from targeted policy actions to foster the development of a secondary market for distressed debt.
Importantly, the most affected banks have to focus on enhancing their external disclosure and, thus, better communicate to the market, in order to reduce areas of uncertainty attached to their book values and risk exposure.