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At the end of 2016 the gross value of non-performing loans (NPLs) in the EU’s banking sector reached almost EUR1.1 trillion (about 5 per cent of total loans), and in net terms (gross value minus any deductions) – EUR554bn. The average value of NPL ratio in the EU is 5.1 per cent but the NPL level varies substantially from 1-2 per cent (e.g. in Luxembourg and Finland) to almost 50 per cent (in Greece and Cyprus), while in over one third of EU member states it exceeds 10 per cent.
In its report, the European Systemic Risk Board emphasizes that the high ratio of NPLs constitutes not only a micro-prudential problem, but also a macro-prudential one, and it influences the stability of the financial system as it reduces the effectiveness of the banking sector, lowers its capacity to finance the real sector and delays the return to economic growth. Currently, the rate of decline of non-performing loans is too low and a further delay of that process may undermine investor confidence in banks and have negative impact on the real economy.
Solving the problem of NPLs requires making a decision on the allocation of the losses between the stakeholders (lenders, borrowers, shareholders, creditors, and the public sector) and spreading these losses over time. The report presents five main rules which should be applied in order to reduce the rate of NPLs:
- swift action aimed at diagnosing the NPLs and lowering their quantity in a way that does not lead to abrupt sale of assets is indispensable;
- the losses should be borne mostly by shareholders of banks and other investors, to prevent moral hazard;
- the introduced solutions must be in compliance with the European legal framework – especially when concerning state aid as well as bank restructuring and resolution;
- an assessment of the possibility of a given bank continuing its commercial activity should be conducted as a part of the NPL reduction process because a part of the EU banking sector may require corrective actions or resolution;
- a comprehensive approach is required to solve the problem of the high rate of non-performing loans and related irregularities in the functioning of the market.
Moreover, the report presents the sequence of actions that should be taken in order to decrease the high rate of NPLs. These include:
- defining the magnitude of the problem of NPLs in a given bank and separating NPLs from other assets of that institution;
- valuation of the NPLs and a decision on their restructuring, sale, transferring to the Asset Management Company (AMC), securitization or writing off as losses;
- assessment of the ability to continue long-term commercial activity by the part of the bank that is left after the removal of bad assets – but the results of that assessment should be used to decide whether the bank should be restructured, joined with another bank, sold or liquidated.
What is more, micro-prudential supervisors should strive for the swift and widespread implementation of good practices and an improvement in the management of non-performing loans by banks through the standardization of definitions used in banks with the EU definitions and also prudent valuation of NPLs (including collateral). Micro-prudential supervision should also oblige banks with high NPL rates to provide regular information on their reduction strategies and also data that is necessary to assess the bank’s ability to continue its commercial activity after resolving the problem with these assets. In addition, the effect of implementing plans for a reduction of non-performing loans, estimated for the entire economy, should be agreed with the macro-prudential authorities. On the other hand, at an EU level, a strategy concerning the establishment of national companies managing assets should be developed. Thanks to these companies, the sale of the NPLs would be possible.
In the medium-term, in order to increase the rate of NPL recovery rate, changes to legal frameworks concerning insolvency, recovery of debts and legal service of non-performing loans should be introduced.
In the long-term, in order to prevent a future increase in NPLs, a proper system of incentives for banks should be introduced to allow the quickest possible accounting for non-performing loans. Moreover, the establishment of trading platforms for non-performing loans should be taken into consideration.