It is a well-known fact that the European banking sector struggles with a high stock of non-performing loans (NPL). The publication of the results of the EBA stress test in July has brought public attention again to the tensions in the European banking sector resulting from a NPL stock of approximately €1.1 trillion and an average NPL-ratio of 5.7% (almost three times as much compared to the US or Japan).1 In addition, NPLs vary widely across EU countries (see figure 1). The tensions from the high stock of NPLs represent a multi-faceted threat to the ECB’s supervisory priorities for the three reasons:
All of this contributes to a weaker banking sector, with less capacity to lend to the European economy.
The ECB has addressed NPLs in a number of ways, such as the AQR and stress test within the comprehensive assessment 2014, establishing an SSM NPL Task Force in 2015 and by defining NPLs as a key priority for 2016.
After nearly one year of work by the NPL Task Force, the ECB has published a substantial (126 page) guidance to banks on NPLs. Their objective is to drive strategic and operational focus on the reduction of NPLs, together with further harmonization and common definitions of NPLs and forbearance. Success for the SSM would be driving adoption of NPL workout strategies across the Banking Union, thereby helping to speed up European NPL-sales transactions and increasing the liquidity of NPL-markets (see also our earlier article). The ECB has also released a stock take of national supervisory practices and legal frameworks related to NPLs in eight countries.2
Figure 1: Non-performing loan ration by country and size class, end of March 2016
Source: EBA Risk dashboard.
Notes: (1) * Not reported. (2) Weighted Averages by country.
The guidance is addressed to significant institutions directly supervised by the ECB. Applying the principle of proportionality, the ECB considers some chapters of the guidance (i.e. strategy, governance and operations) to be more relevant for high NPL-banks. Interesting to note, the guidance defines high NPL banks as banks with a NPL level ‘considerably higher than the EU average level’.
Although the guidance is a non-binding supervisory instrument, non-compliance may trigger supervisory measures that are not further specified in the guidance (though a higher SREP Pillar 2 capital requirement cannot be ruled out). The ECB acknowledges that addressing NPL will require a medium-term focus, and therefore expects that banks will implement the guidance proportionately and with appropriate urgency and with close engagement of their Joint Supervisory Teams. The ECB is also aware of its interdependency on other stakeholders, including the EBA and European Commission, as well as national legislators, law courts and insolvency practitioners.
The structure of the guidance follows a NPL management lifecycle and includes six chapters together with seven annexes that contain best practice examples, some of which are summarized below.
Clearly, the ECB expects from SSM banks a thorough roadmap for their NPL-management and has formulated its expectations regarding the roadmaps’ granularity on topics like:
The guidance also requires a strict and separate oversight during all NPL-management processes, i.e. with regard to:
The guidance also outlines some general principles for the categorization of viable forbearance solutions:
The guidance also aims to enhance a further harmonization of NPL definitions within the SSM, in particular with regard to:
Furthermore, the guidance specifies criteria for the:
Similar to the NPL recognition, the guidance also specifies criteria for the collateral valuation of immovable property, such as the:
The guidance represents a comprehensive approach from the ECB to improve the NPL management of SSM banks and is likely to increase NPL-management costs for both low and, in particular, high level NPL-banks (see figure 2). Due to that, it appears that high level NPL banks are pushed further towards non-viability, while for others the full implementation of the requirements are likely to increase operational costs of their NPL-management.
Figure 2: Non-performing loan ration by size class, end of March 2016
Source: EBA Risk dashboard.
Note: Weighted average. Banks are classified in the size class according to their average total assets between Dec. 2014 and March 2016.
The public consultation of the draft guidance will last until November 15. Given the potentially large impact for some European banks, it will be important how the market perceives the ECB’s harmonization effort of European banks’ NPL management framework and to what extent the guidance can further harmonize cross-border differences in European NPL-markets. For the future, the ECB has already announced that it plans to place a stronger focus on enhancing the timeliness of provisions and write-offs by extending the scope of the guidance.
Given that previous ECB consultations have typically resulted in limited adjustments rather than wholesale changes, banks are well advised to analyze thoroughly the main requirements of the NPL guidance and to begin a gap analysis against their own strategy, operations and systems.
For further details on this topic, please contact Marcus Evans or David Nicolaus, or connect with KPMG’s Portfolio Solutions Group – a team based in the UK firm, which specializes in the sale and purchase of loan portfolios across Europe and beyond.
1 Absolute number for large European banks only. Sources: EBA, World Bank.
2 Countries included in the stock take Cyprus, Germany, Greece, Ireland, Italy, Italy, Portugal and Spain.