European Parliament published two papers that discuss non-performing loan (NPL) resolution after the COVID-19 pandemic. One of the papers assesses the impact of COVID-19 on the European corporate and banking sectors and the extent to which lessons learned from the global financial crisis are applicable to the policies that should be put in place for NPL resolution after the pandemic. The paper assesses the potential consequences for NPL resolution on bank balance sheets after pandemic, analyzes the number of zombie firms that banks may still be lending to in EU, and raises some important policy considerations for how to manage the volume of NPLs that may accrue. The other paper examines policy implications of a potential surge in NPLs due to the COVID-19 pandemic; the paper provides an empirical assessment of potential scenarios and outlines lessons from previous crises for effective NPL treatment.
The paper on policy implications highlights the importance of early and realistic assessment of loan losses to avoid adverse incentives for banks. Secondary loan markets would help in this process and further facilitate bank resolution as laid down in the Bank Recovery and Resolution Directive (BRRD), which should be uphold even in extreme scenarios. In the empirical analysis, the authors of the paper find that aggregated bank capital seems to be large enough to absorb potential NPL losses, even in an adverse scenario. However, relevant buffers above and beyond the minimum required capital may not always be sufficiently high. To find an effective and efficient strategy dealing with potentially high NPL levels in the future, the paper examined previous crises and established certain key lessons on NPL identification, recognition, and resolution that are all also likely to be of importance during the COVID-19 pandemic:
- If NPLs are not identified and recognized efficiently, both in terms of speed and scope, NPL resolution effectiveness is undermined.
- Regulators and supervisors should ensure that banks assess current loan values realistically, which can be achieved by effective Asset Quality Reviews, stress tests, adequate accounting rules (such as the new IFRS 9 standard), and inspections that impede banks masking their risk. Realistic loan value assessment will incentivize banks to recognize NPLs early and to handle NPLs efficiently, either by internal workouts or by selling them on secondary markets.
- Forbearance or public bank recapitalization (and other state aid) are not well-suited to solve the NPL resolution problem efficiently, as they provide adverse incentives to banks.
- European secondary market for NPLs has the potential to be an important component of a successful NPL resolution. Policy makers are well-advised to overcome existing obstacles hindering the development of these markets, such as information asymmetries between the seller and buyer and the banks’ lack of incentives to sell loans at market prices.
Regarding the EC Action Plan, the authors of the paper agree that a vitalization of the secondary loan market may be a promising step toward more resilient banking system. A liquid and transparent secondary loan market would allow banks to achieve higher prices when forced to sell NPLs, thus lowering their loss of capital even in critical times. A strong and well-developed secondary loan market, therefore, can contribute to the stability of the banking sector in an economy. Moreover, it can improve the loan-quality information that is available for investors and originators alike. Thus, the report notes that any plan to deal with NPLs should consider bank restructuring and resolution as the alternative, probably the preferred alternative, to recapitalization or any other rescue measure.
Keywords: Europe, EU, Banking, COVID-19, NPLs, Resolution Framework, BRRD, Systemic Risk, Credit Risk, Recovery and Resolution, Regulatory Capital, European Parliament
Leading economist; commercial real estate; performance forecasting, econometric infrastructure; data modeling; credit risk modeling; portfolio assessment; custom commercial real estate analysis; thought leader.
Previous ArticleECB Updates Annexes to AnaCredit Reporting Manual in March 2021
The three European Supervisory Authorities (ESAs) issued a letter to inform about delay in the Sustainable Finance Disclosure Regulation (SFDR) mandate, along with a Call for Evidence on greenwashing practices.
The Financial Stability Board (FSB) and the Network for Greening the Financial System (NGFS) published a joint report that outlines the initial findings from climate scenario analyses undertaken by financial authorities to assess climate-related financial risks.
The Financial Stability Board (FSB) published a letter intended for the G20 leaders, highlighting the work that it will undertake under the Indian G20 Presidency in 2023 to strengthen resilience of the financial system.
The International Sustainability Standards Board (ISSB) of the IFRS Foundations made several announcements at COP27 and with respect to its work on the sustainability standards.
The International Organization for Securities Commissions (IOSCO), at COP27, outlined the regulatory priorities for sustainability disclosures, mitigation of greenwashing, and promotion of integrity in carbon markets.
The European Banking Authority (EBA) issued a statement in the context of COP27, clarified the operationalization of intermediate EU parent undertakings (IPUs) of third-country groups
The European Union has finalized and published, in the Official Journal of the European Union, a set of 13 Delegated and Implementing Regulations applicable to the European crowdfunding service providers.
The Office of the Superintendent of Financial Institutions (OSFI) published an annual report on its activities, a report on forward-looking work.
The Australian Prudential Regulation Authority (APRA) finalized amendments to the capital framework, announced a review of the prudential framework for groups.
The Bank for International Settlements (BIS) Innovation Hubs and several central banks are working together on various central bank digital currency (CBDC) pilots.