The EBA today issued a report on recent trends in asset quality in the EU banking sector. The analysis is based on supervisory data on non-performing loans (NPLs) and forbearance (FBL) for over 160 EU banks. The report shows that despite improvements NPLs remain high, with associated implications for the economy and bank's profitability. The report identifies various structural impediments to addressing NPLs and sets out three key areas for improvement.
The EU banking sector has seen significant capital strengthening since 2011, which is a pre-condition for addressing the quality of banks' balance sheets. Asset quality reviews carried out since 2014 have contributed to identification, and some reduction, of NPL ratios but the overall level of legacy assets remains high, albeit uneven across countries.
With an average ratio at 5.7% in March 2016 – NPLs in the EU remain up to three times higher than other global jurisdictions. The EBA found that while the definitions of non-performing assets and provisioning rules are now mostly aligned across the EU, there still are very significant differences in some of the key structural areas that affect banks' capacity to deal with NPLs.
Structural impediments include legal systems, the duration of court proceedings and tax regimes, which the EBA found to vary significantly across the EU, as well as the absence of a deep and liquid secondary market in NPLs. According to the report, the major impediment to reliable and fast insolvency procedures is the slow process and significant work-overload of some judicial systems, especially those with high NPL ratios. The link between the expected duration of insolvency proceedings and coverage ratios seems to confirm that provisions strongly depend on collateral posted, recovery rates and the speed of the recovery process. Out of court restructuring of debt under judicial supervision could be an alternative path for many insolvent clients, but it is not frequently used.
The EBA's report also identifies some policy options for removing or easing the impediments to NPLs resolution.
The first area is to support the ongoing supervisory work to push for improved provisioning and arrears management.
The second area is to address structural issues, such as backlogs in judicial systems and processes. Since the length of recovery procedures has an inverse relationship with the ask-bid spread, improvements in judicial process and use of out-of-court restructuring could help to improve the marketability of NPLs.
A third area relates to the liquidity, transparency and efficiency of secondary market in loans to facilitate the disposal of NPLs. Enhanced transparency regarding the state of NPLs and real estate collateral valuation would contribute to a better understanding and pricing of the risks and, ultimately, facilitate the sale process and lead to lower discounts in secondary market transactions. The establishment of asset management companies (AMCs) – with or without public support – can also play a key role in resolving NPLs and is a key factor in price discovery. The EBA concludes that the revival of the EU market for debt securitisation may be a way of widening the range of options that banks could consider for dealing with their NPLs, but stressed the need for supervisory guidance in tackling NPLs, particularly in collateral valuation and arrears management.