The large legacy overhang of Non-Performing Loans (NPLs) is increasingly seen as a threat to the success of the Banking Union.
The large legacy overhang of Non-Performing Loans (NPLs) still remaining in the European Union (EU), with nearly €900 bn in the Eurozone alone, is increasingly seen as a threat to the success of the Banking Union. Regulators have recently increased their intervention to help speed up the banks' NPL risk deleveraging process.
Over the past 18 months, numerous NPL task forces have been debating the topic to define the possible “optimum” pan-European solutions.1 In July 2017, the EU Council announced an Action Plan to tackle the issue.
The ambitious plan introduced several initiatives to be implemented in a remarkably short timeframe (mostly in 2017-2018). The topics covered are broad, ranging from strengthening banks' management of NPL stock, to increasing incentives for banks to adequately provision and deleverage risks, as well as preventing new flows of NPLs in the future. Important progress is already being made, in line with the plan.
In March 2017, the European Central Bank (ECB) published its NPL guidance for significant institutions (PDF 1.98 MB), which has put considerable pressure on high NPL banks under Single Supervisory Mechanism (SSM) supervision to produce robust and detailed NPL strategies and demonstrate their ability to deliver operationally on those plans. The European Banking Authority (EBA) is also expected to issue guidelines on NPL management in 2018, to be applicable to all banks in the EU. This will add pressure on less significant institutions to begin actively addressing their NPLs.
Regulators are intending to further encourage NPL reductions by increasing the cost of holding them on the balance sheet. For example, the ECB is completing its supervisory expectations for provisioning on new NPLs (expected to come into effect by mid-2018). While this is a non-binding guidance, non-compliance will have the potential to trigger pillar 2 measures (e.g. close supervisory monitoring or capital add-ons) for significant institutions. An additional provisioning backstop proposal from the European Commission (EC) would affect all banks in EU-27 countries and also have direct implications on Pillar 1 capital requirements. However, it is currently unclear how these two sets of measures will coexist. The ECB's guidance will probably bridge the gap until the EC can implement its measure, expected to be a multi-year process if incorporated in CRR3.
Improving standardisation and comparability of banks' NPL data is also a top priority. For example, the EBA published its NPL templates on 14 December 2017 (for which KPMG was the adviser), which aims to set new market standards for NPL transactions.
The collective effect of these actions is to significantly increase the pressure on banks of all sizes to address their NPL backlog. Even banks with low levels of NPLs need to start assessing the impact of the NPL Action Plan of the EU Council, if they have not done so already.
The regulatory oversight for NPLs will continue to have a considerable impact on banks. As a result, we expect to see more NPL portfolios for sale in the EU market over the coming years. More elaborate alternatives to the traditional “direct sales” are also likely be used by banks to deleverage their NPL risks. Further pan-European initiatives by the regulators could also increase the options available to sellers and buyers, including the ECB's idea for creating a NPL transaction platform (PDF 118 KB) and the design of the AMC Blueprint in progress by the EC.
In the short term, EU banks need to understand that they are facing a ‘new normal’, with NPLs becoming much more costly and demanding over the next few years for banks to hold, requiring banks to revisit their NPL strategy and operational plan accordingly.