NPL: Introduction of prudential provisioning backstops
EU in the offing?
In spring 2018, the EU Commission published a package of measures on how to deal with non-performing loans (NPLs), which, amongst other things, provides for the introduction of prudential provisioning backstops for new loans that being categorised as non-performing at a later date. During the current negotiations in trilogues, in other words the negotiations between the EU Commission, Council and Parliament, the EU Council published a proposed compromise for a regulation to amend the CRR (2018/60 [COD]) on 29 October 2018. The EU Parliament’s draft report followed on 8 November 2018. Both drafts contain some deviations from the EU Commission’s proposed amendment regulation with respect to the definition of exposures and the deduction rules for non-performing exposures (NPEs).
Exposures to be considered in risk provisioning
In order to identify the Common Equity Tier 1 deductions, pursuant to the newly introduced letter m in art. 36, section 1, all debt instruments such as debt obligations, loans, lines of credit, sight deposits, all loan commitments and financial guarantees given must be taken into account. In contrast to the EU Commission’s draft, the EU Council and Parliament propose dropping deposits with central banks and loan commitments that are revocable at any time from the definition of exposures to be taken into consideration and therefore removing them from the deductions from the common equity.
Both amendment proposals retain article 47c, which had been proposed for adoption into the CRR by the EU Commission back in March 2018. It specifies how the deduction from common equity is calculated by comparing the minimum coverage requirements (through listing the multiplication factors to be applied to unsecured and secured NPEs) with the components available to meet provisioning requirements. Key differences concern the point in time at which minimum coverage is to provide and the level of the multiplication factors.
In contrast to the EU Commission’s proposal, following the backstops proposed by the EU Council and EU Parliament, the banks are granted more time to create the regulatory provisioning. In detail, the EU Council demands minimum loss coverage for unsecured and secured NPEs two, respectively three years after their categorisation as NPEs, while the EU Commission stipulates minimum coverage requirements after the first year already regardless of security. The EU Parliament proposes implementation of minimum coverage requirements, regardless of security, only after three years.
However, based on the EU Council and EU Parliament’s proposals, this later formation of the regulatory minimum coverage requirement is compensated for by higher multiplication factors. Consequently, despite the delay in applying coverage, the whole period of time until full coverage would be three years (for unsecured NPEs) or seven years (for secured NPEs) and therefore mostly congruent with the periods of time proposed by the Commission of two (for unsecured NPEs) or eight years (for secured NPEs).
When determining the multiplication factors, the EU Commission also makes a distinction concerning how long the NPE has been overdue, because regardless of the length of time they’ve been classified as non-performing, more conservative factors are to be applied to NPEs that have been overdue for at least 90 days. The EU Council and Parliament do not make this distinction.
A proposal to introduce special factors that distinguish between the type of securities is also new. While the above-mentioned deduction method is to be used for movable collateral, exposures secured by real estate or guaranteed housing loans benefit from a period of time that has been extended to nine years. In the case of NPEs secured by export insurance policies, the obligation to create prudential provisioning backstops for the first time only applies seven years following categorisation as an NPE, but then with a multiplication factor of 100%. Furthermore, the EU Council and Parliament propose that forbearance measures could have a mitigating impact on the prudential provisioning backstops so that in the year in which the forbearance measure was taken the relevant multiplication factor could be applied for a further year.
While the EU Commission proposed to apply minimum coverage requirements to all newly issued or subsequent exposure-enhancing amended credits after 14 March 2018, the Parliament’s and Council’s proposals suggest the date of the amendment regulation coming into force In order to adopt the amendment into CRR II, agreement in Q1/2019 is required. Considering the potentially rapid implementation into European law, users should get to grips with these developments as soon as possible. Furthermore, banks that are overseen as part of the SSM have to include the slightly different prudential provisioning backstops from the ECB which were finalised in March 2018 in their deliberations.