Non-Performing Loans (NPL) management in European banks

The ECB guidance on non-performing loans

July 2017

In March 2017, the ECB published the final version of its guidance for banks on non-performing loans (called NPLs in the rest of the article). The guidance was issued due to the high levels of non-performing loans at European banks of around EUR 879.8 bn in Q4/2016 (see also a comparative study on non-performing portfolios and the EBA’s risk dashboard). NPLs are, without doubt, a problem. Prominent representatives from the banking supervisory bodies have already advocated solutions at a European level, e.g. in the form of a pan-European bad bank.

The ECB’s guidance is a response to the necessity of standards to control NPL-stocks. The authority supervisor defines measures and processes for dealing with NPLs, for example on the basis of best practices at European banks – in particular for banks directly supervised by the ECB. For now the guidance is not compulsory, but serves as a basis for dialogue between the supervisory authority and banks. It deals with the following issues:

NPL strategy

A strategy with qualitative and quantitative objectives and an operational implementation plan is to be developed, based on fundamental requirements in the form of an assessment of the internal and external environment. In terms of implementation options (e.g. hold strategies, NPL sales, write-offs, debt equity swaps or debt asset swaps) a customised combination of options is to be specified that best achieves the objectives set. The strategy is then to be incorporated into business processes and implemented via suitable decision-making structures.



The guidance envisages appropriate governance structures, an early warning process and an operational model for NPLs in order to implement the NPL strategies. The allocation of NPL workout units to focus on specific NPL lifecycles and portfolio characteristics is to help credit institutions pool expertise in handling NPLs and eliminate conflicts of interest.



The objectives prioritised are to restore borrowers’ capability to repay bad debts and to prevent further borrowers from being downgraded to this status. Experience has shown that forbearance measures are often repeatedly taken without any specific impact on the underlying problem. Therefore, the focus is placed on defining and implementing viable forbearance solutions. As a result, an overview is given of possible forbearance options first of all, followed by requirements for checks on the future ability to pay back loans and for duties of disclosure.



Connections between non-performing exposure (EBA), impaired (IFRS) and default (CRR) definitions are explained and procedural harmonisation of the various definitions are recommended in detail. As regards the definition of unlikely-to-pay events, the guidance proposes taking into account incidents that are listed in the CRR’s definition of defaults and in the IFRS’s definition for impairment regulations.


Measurement of provisions and write-offs

The results of asset quality reviews revealed the need for consistent provisioning methodology. Some of the objectives for recognition and write-offs of credit losses are robust provisioning methodology, quick handling and the improvement of processes for measuring asset quality.


Measuring real estate collateral

Above all, inspections by the supervisory authority of real estate collateral indicated deficiencies regarding immovable property valuation. The major point of criticism was the failure to request consistent information as a basis for assessment and therefore an error of judgement concerning collateral and credit quality. The guidance defines expectations vis à vis processes, inspections and controls of real estate assessment and what is required of experts. Furthermore, it includes recommendations on dimensions of the assessment process in terms of timing and method.

Annex 8 of the guidance reacts to comments on the use of securitisation to reduce NPLs. For this purpose, banks are for example advised to make a realistic forecast of cash flows used in cash flow models in relation to irregular repayments of NPLs. The supervisory authority recommends paying particular attention to assessing collateral and taking restructuring costs into account.

The supervisory authority believes that Europe-wide harmonisation in dealing with NPLs will be a further step towards reducing the NPL burden. While banks with significant NPL-stocks are to implement governance structures and NPL strategies to reduce non-performing loans swiftly, other sections of the guidance apply to the whole range of credit institutions. All credit institutions are accordingly advised to take preventative action by following requirements on forbearance, NPL recognition, measurement of impairment provisions and write-offs and real estate collateral. They are also encouraged to use early warning systems to prevent the increase of NPLs in their portfolios.

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