In June 2017, the European Central Bank (ECB) declared the Banco Popular Español S.A. to be “failing or likely to fail” and advised the Single Resolution Board (SRB) to set up a plan for the credit institution’s resolution. One of the main reasons for bank failure is a high ratio of non-performing loans (NPLs) relative to its total loans. In fact, the Banco Popular had a NPL-ratio of over 20%.
This particular case highlights the problem of NPLs in Europe, which has been identified by authorities as one of the main risks to profitability and sustainability in the European financial markets. Although the significance differs across countries, it is very much an EU-wide concern with more than EUR 1 trillion in NPLs, 10 countries with an NPL ratio above 10%, bank/sovereign links, spill-over risk and an overall impairment of the lending channel for monetary policy.
Banks’ lack of incentive to dispose of assets at a loss, structural failures such as lagging legal systems, the information asymmetry between buyers and sellers (of impaired assets) and intertemporal pricing problems represent market impediments to solve the NPL problem.
One strategy for NPL management (especially during restructuring processes of banks) is the establishment of an asset management company (AMC) or a so-called “bad bank”, which are used to cleanse bank balance sheets transferring the bank’s non-performing assets. The Chairman of the European Banking Authority (EBA), Andrea Enria, presented on 30 January 2017 his proposals on an EU-wide AMC in order to tackle NPLs more uniformly. He introduced a spectrum of possible public-sector actions, which range from improving data quality and consistency on NPLs and collateral, through an EU master agreement on NPL disposal and a blueprint for national AMCs, all the way to the establishment of a Single EU AMC.
On 3 February 2017 Vítor Constâncio, the vice-president of the ECB, delivered a key note speech on NPLs, evaluating pros and cons on the establishment of EU-regulated AMCs and concluding his evaluation by recommending the creation of a European blueprint for AMCs to be used at national level. Following a letter dated 29 March 2017, in which Valdis Dombrovskis, the president of the European Commission (EC), asked the EBA to (among other things) further improve the NPL data’s granularity, quality and comparability, the EBA began work on the identification of data needs for NPL disposal and the preparation of NPL reporting templates and the accompanying instructions. Mandatory NPL reporting through standardised templates could represent one of several necessary and important steps in addressing market failures and provided the necessary level playing field to encourage the further development of secondary markets in NPLs, with or without the establishment of a Single EU AMC.
The EC’s Reflection Paper on the Deepening of the Economic and Monetary Union of 31 May 2017 further specifies the need for a harmonised approach on NPLs and its consultation paper published on 11 July 2017 (and to run until 20 October 2017) furthers the work on the development of secondary markets for NPLs and distressed assets.