By Theodoros Alepis
It has been widely recognised that the high level of nonperforming loans (NPLs) in certain European countries is an obstacle to economic growth and a burden on their banking sectors. A loan is classified as non-performing if repayment is more than 90 days in arrears or if the loan is assessed as unlikely to be repaid by the borrower. In particular, high levels of NPLs:
Require high levels of provisions from banks to cover for expected losses. High provisioning consumes banks’ capital and places them at a disadvantage in upcoming regulatory exercises (stress tests etc).
Consume significant existing bank resources (both human and financial). This hampers banks’ ability to lend to healthy sectors of the economy.
Require additional bank resources to tackle the issue, such as the necessity to create special servicing units and to seek specialised consulting services which come at a high cost.
The countries with the highest NPL ratios in Europe are Greece at 47%, Cyprus at 43% and Italy with 18% of total loans. There are reasons why NPLs in these countries remain high, primarily structural/legal impediments (for example retail mortgage borrowers may be overly protected, there are no out-of-court restructuring arrangements, there are limitations on the sale of certain types of collateral etc) as well as the increase in the number of defaults as a result of the economic recession. The European Commission is currently taking a series of actions to reduce NPLs and bring further homogeneity across banks in the EU (the ratio of NPLs as a percentage of total lending in EU banks is 4.6%). According to a report published in January 2018 a comprehensive package for tackling high NPL ratios is being put in place. The package consists of the following measures:
Initiatives to set up Asset Management Companies (AMCs) at a national level. This should be done in compliance with existing EU banking and State aid rules and modelled on best practices adopted by other more experienced countries. In order not to violate EU State aid rules, the transfer of NPLs to the AMC should be done at arm’s length prices, meaning at prices close to market levels.
Introduction of further backstops to prevent the risk of under-provisioning of NPLs. One working paper introduces full provisioning of 100% of new loans as of Jan 1, 2018 after 2 years if it is non-collateralised and 7 years if the loan has collateral.
Introduction of measures to enhance the protection of secured creditors by allowing them more efficient value recovery through the Accelerated Extrajudicial Collateral Enforcement mechanism (AECE). This will provide banks with an out-of-court mechanism to enforce secured loans against companies and individuals subject to a common agreement.
Fostering transparency in NPLs in Europe by improving data availability and comparability. This can be done by setting up a common platform to license loan servicers and loan administrators. This is imperative to further develop the secondary market for trading NPLs that is currently very weak at EU level.
It is further expected that these tools, along with the further improvements in the economies of EU member states will help to further reduce the NPL ratio and bring greater homogeneity among EU countries. For Cyprus in particular, enactment of the securitisation law is expected to further assist in deleveraging the high level of NPLs on banks’ balance sheets. In addition, current plans by the government of Cyprus to create a national AMC company will further facilitate the reduction of NPLs in the banking system.
Theodoros Alepis is vice president of the CFA Society Cyprus