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January 28, 2019

ESRB published a report on macro-prudential approaches to non-performing loans (NPLs). The report focuses on the role that macro-prudential policy can play in preventing system-wide increases in NPLs and in strengthening bank resilience to such increases. It identifies the main triggers, vulnerabilities, and amplifiers that can drive system-wide increases of NPLs, drawing on the experience of ESRB members, especially those from member states in which such increases were observed in the aftermath of the recent crisis.

The report presents an analysis performed by ESRB in response to a request from the Council of the European Union to "develop macro-prudential approaches to prevent the emergence of system-wide NPL problems, while taking due consideration of procyclical effects of measures addressing NPLs’ stocks and potential effects on financial stability.” The report not only highlights the business cycle and asset price shocks as two of the main drivers, but also acknowledges the role played by vulnerabilities built up before the crisis—such as excessive credit growth, high indebtedness, and banking practices—and structural factors such as weaknesses in the legal and judicial system.

In terms of macro-prudential policy approaches, the report concludes that while no fundamental changes to the existing macro-prudential toolkit seem to be required, some refinements should be considered. Further work is needed in areas such as the use of sectoral capital buffers and the development of borrower-based measures (for both households and non-financial corporations). Capital-based instruments should also be considered to address vulnerabilities that could later result in system-wide increases in NPLs. Moreover, the macro-prudential authorities should develop early warning systems to monitor the risks of credit portfolio deterioration from a macro-prudential perspective. Finally, some of the triggers of system-wide NPL problems fall outside the scope of macro-prudential policy, notably the legal and judicial framework as well as banks’ governance structures. Nevertheless, they determine the circumstances in which any macro-prudential policy approach will have to be developed, and, as such, deserve consideration in designing macro-prudential approaches to NPLs.


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Keywords: Europe, EU, Banking, NPLs, Systemic Risk, Macro-prudential Policy, ESRB

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