The ECB considers that levels of Non Performing Exposures (NPE) on Banks under its supervision are too high. Therefore, set this topic as a priority for 2016. In seeking a sustainable and viable business model, the ECB is clear that this issue must be dealt with head on and prevarication only serves to delay the reestablishment of profitable business models. The priority placed in 2016 on business model analysis serves to highlight the importance of the dialogue with the industry on this topic and the need to move forward. Nevertheless, the issue is multifaceted and aside from the accounting issues of definition, it also raises important public policy issues. Direction on NPE sales from the supervisors has a potential for huge disruption to a bank’s capital plan.
Currently, the definition of NPE depends on several aspects: applicable accounting framework, internal or external view and countries, etc. On an internal level of a single bank, a NPE definition should be closely related to the credit processes. From an accounting perspective IFRS use neither forbearance nor non-performing definition. Also the US-GAAP definition of problem loans (troubled debt restructurings according to "FAS 15," loans accounted for on a nonaccrual basis and accruing loans which are contractually past due 90 days or more as to principal or interest payments) is different in comparison to IFRS.
On 21 October 2013 the EBA released two definitions as amendments of the common EU-wide IFRS Supervisory reporting framework (FINREP): Definition of Non-Performing Exposures (NPE) and Definition of Forbearance (FBE) to harmonize different national practices. According to the EBA, the existing accounting and regulatory frameworks were useful starting points but had to be complemented.
In the Asset Quality Review performed by ECB in 2014, the EBA definition was used by the ECB.
Due to weak economic growth the level of NPE increased in the Eurozone countries since 2008 to more than €932 billion at the end of 20141. The recently published EBA transparency exercise states that on a bank level the non-performing loans are close to 6 percent of total loans and advances, and are 10 percent when only exposures towards non-financial corporations are considered across the EU. Smaller banks2 report higher aggregate NPE ratios for loans and advances, at about 18 percent, compared to 9 percent for medium-sized banks and 4 percent for larger banks.3 According to the "Risk Assessment of the European Banking System" published by the EBA in December 2015, Small and Medium Entities (SME) loans show the highest ratio of non-performing loans compared to other segments (large corporates and households) at EU level and in many Member States. From a country perspective the NPE ratios reached exceptionally high levels in Cyprus and Greece by the end of 2014.
Due to the high number of NPE, banks have to manage proactively their NPE to remove drag on earnings from these assets by taking measures to sell or restructure these exposures.4
In late 2015, the ECB sent a request for information to many banks requesting information on the level of NPE. This request came from the NPL taskforce which has been established to articulate a euroarea approach to tackling this issue. The NPL taskforce may end up setting targets for disposals of NPE.
To sell NPE is not a simple task as the market for NPE in Europe is relatively small and underdeveloped compared to the size of the outstanding stock of NPE and is more focused on commercial real estate and consumer loans.5 Challenges for a NPE market are for example long restructuring periods and limited liquidity in real estate markets. Another question is the lack of information for example with regards to land registration in some countries, uncertainties regarding tax and VAT requirements as well as differences in legal systems and with regards to the underlying collateral.
The recommendations from the ECB taskforce will be closely monitored by all market participants. Banks need to be in a position to rapidly assess the impact of any recommendations arising here.
In December 2015, Marcus Evans (KPMG Partner for Deal Advisory at ECB Office) and Eric Cloutier (KPMG Director seconded to the EBRD) met with ECB, the SSM NPE Task Force and IMF to discuss challenges and chances arising from NPE in Europe and what is needed to create a dynamic NPE market.
1Source: IMF Staff Discussion Note “A Strategy for Resolving Europe’s Problem Loans”, September 2015
2According to EBA the group of small banks is defined as those banks in the fourth quartile of the sample of the transparency exercise in terms of total assets. Medium banks are those in the second and third quartiles, and large banks are those in the first quartile
3Source: EBA Transparency exercise, November 2015
4Source: KPMG publication: Evolving Banking Regulation Part Two, April 2015
5Source: IMF Staff Discussion Note “A Strategy for Resolving Europe’s Problem Loans”, September 2015