Sunday, November 27, 2016

EU Economy - The high stock of non-performing loans (NPLs) on the balance sheets of euro area banks continues to be an important cause for concern for policymakers .. - ECB

Publication - Addressing market failures in the resolution of nonperforming loans in the euro area (Special Feature of the Financial Stability Report, November 2016)


Addressing market failures in the resolution of nonperforming loans in the euro area1 

The high stock of non-performing loans (NPLs) on the balance sheets of euro area banks continues to be an important cause for concern for policymakers. 

Efforts to resolve this problem have increased significantly in the course of 2016, by supervisors and macroprudential policymakers alike. To relieve capital constraints, these efforts, however, must be complemented with structural reforms to recover the value of NPLs in some countries. Against this background, this special feature focuses on impediments to the functioning of a market for NPL sales. It highlights sources of informational asymmetry and structural inefficiencies.

 Among indicators of market failure, it distinguishes between supply and demand factors that impede market functioning. In light of the identified externalities, public policy responses are warranted to reduce the cost and duration of debt recovery while also addressing information asymmetries between better-informed banks and potential investors. In certain circumstances the establishment of asset management companies (AMCs) may help to accelerate the value recovery process for banks, while avoiding adverse macroeconomic side effects. Constraints on and limitations of AMCs are also reviewed in this special feature.


History has shown that financial crises and/or prolonged economic contractions often trigger a rapid and substantial increase in non-performing loans, as asset valuations decrease and borrowers become unable to service their debt. In the euro area context, macro-financial stresses over recent years have resulted in the accumulation of significant stocks of NPLs. At the end of 2015, the 130 largest euro area banks held around €1 trillion of impaired assets, although NPL ratios are very unevenly distributed across euro area countries (see Chart B.1). 

Moreover, although over 60% of NPLs are related to various forms of corporate lending, the type of assets affected by the loan quality deterioration is quite heterogeneous. The size of the overall stock of NPLs in the euro area, the challenge it poses to bank profitability, and the financial and economic interlinkages between euro area countries give rise to area-wide financial stability and macroprudential concerns. It may also have an impact on the transmission of monetary policy, as bank resources are tied up by inefficient lending, and on fiscal risks. 



The ECB has been flagging the importance of the NPL problem in the euro area for some time already. In its comprehensive assessment of 130 euro area banks in 2014, it applied for the first time a common NPL definition to identify the magnitude of the problem.2 In 2015, it presented a first overview of the scale of the problem, highlighting key operational aspects that are critical for effectively resolving NPLs and outlining the advantages and disadvantages of different resolution strategies.3 In September 2016, the ECB’s Single Supervisory Mechanism (SSM) launched a public consultation on guidance to banks on how to tackle NPLs. 

The guidance document provides recommendations on a wide range of microprudential aspects related to NPLs.4 Other international and European bodies such as the International Monetary Fund (IMF), the European Banking Authority (EBA) and the European Bank for Reconstruction and Development (EBRD) have also recently stepped up their analytical and policy work relating to NPLs.5



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