According to the European Banking Authority (EBA), in the second half of 2016 and in a total of 131 banks, NPLs already account for 5.4% of total lending. However, in one third of all banking institutions NPLs appear to exceed 10% of their total lending, while Cyprus and Greece being in the first places and far from the average, have NPLS around 46% of their total lending, followed by Portugal and Slovenia close to 20%. Italy is at 16%, and Ireland close to the limits of 14%.
According to EBA, in Cyprus, 6 out of 10 loans (60%) in small and medium-sized enterprises (SMEs), as well as in large enterprises are ranked as non-performing, while more than half of household loans (55%) have also been ranked as non-performing. Similarly, in Greece, NPLs in SMEs account for more than 65%, followed by households around 46%, while large businesses are around 38%.
The above reveal a need for reduction of NPLs in order to reduce capital deficits and stabilize the domestic economic environment. To this end, the following practices are followed:
- Securitization of NPLs and their transfer to a special purpose vehicle company which will be created for that purpose and consequently may utilize as collateral those securitized loans for any subsequent issue of a bond. Recently in Greece, Alpha Bank in 2016 proceeded to securitization of loans amounted €320 million, while ATTICA BANK already proceeds with the securitization of € 1.331 million. It must be noted that the aim of similar actions is to restore the capital adequacy ratios to normal levels, ensuring, above all, the smoothness of the banking system.
- Assignment to a third party portfolio manager specialized in the NPL management, the controlling and the administration of NPLs, while at the same time the bank to be able to maintain ownership of those portfolios in its books. This will enable Banks’ management and investment committees to focus only on actions that bring growth to their institutions and relieve them from activities that are usually far away from traditional banking purposes.
- Direct sale of the NPL portfolio to third parties. However, this option may counter obstacles, as the buyer will seek to put market prices lower than the fair value, while the Bank may not want to record higher losses than the existing ones.
- Establishment of a securitization market regulatory framework and thus contributing to the implementation of a legislative environment, while favoring additional funding conditions.
- Provision of significant incentives in order to achieve higher responsiveness on behalf of the borrowers. Such incentives could include the write-off of a significant portion of the loan, reduced bank charges, discounts, etc.
- Upgrading the procedures and requirements of monitoring from the stage of the initial credit risk assessment, as well as of the role of Internal Audit and Credit Risk Officer. The emerging implementation of International Financial Reporting Standard 9 (IFRS 9) will support this early tracking, but should be done by reviewing existing credit risk models and credit monitoring tools. Existing databases should be integrated with the new tracking tools, providing clear visibility about the borrower's status.
Finally, it is also worth mentioning that the development of such practices should be closely monitored by a supervisory authority and should be part of specific implementation and legal protection frameworks, in order to avoid any negative impacts on wider society.
More efficient management will release larger resources to the productive sectors of the economy, resulting to increased productivity and growth. In addition, it will separate the real “bad-payers”, who may benefit from ineffective and immediate sanctions, from those creditors who may have difficulties but demonstrate a real intention of repayment. The ultimate challenge is not to replace NPLs with new loans which in turn will revert to NPLs, thus creating a vicious circle by transferring the problem to the next balance sheets. The core aim should be to secure a healthier financial environment capable to produce growth and stability to economy and society.
Author: Constantinos Kypriotis, Senior Manager, KPMG Limited