25 May 2017

OECD: Solving Non-Performing Loans in Europe to speed up the recovery

Impaired assets are a legacy of the crisis, but also a cause of the weak recovery as they limit bank capital available to more productive and innovative firms  The negative impact of impaired assets on bank credit may worsen from 2018 as the new accounting standards (IFRS9) and more forward-looking provisioning rules should lead to faster recognition of losses.

Given this context, it is urgent to pursue a more aggressive policy to resolve NPLs, preferably at the European level. This requires introducing more flexibility in EU rules, including state aid rules, which may otherwise block the most ambitious options to resolve NPLs, as discussed below and outlined in the last OECD economic survey on the euro area.

To free-up maximum capital for new lending, banks need to sell NPLs at a sufficiently high price. This is tricky since potential buyers not knowing the exact level of risk associated with NPLs are likely to offer the lowest possible price and banks may consider the offered price too low, ending up in no transaction. The longer NPLs stay on the books, the lower is the value obtained after removal from the bank, which could make transactions increasingly difficult overtime.

To facilitate transactions, setting up an asset management company (AMC) can be very effective. AMCs’ expertise for valuing impaired assets allows banks, especially smaller ones, to get a better price. Establishing an AMC at the European level would maximize economies of scale and diversify asset recovery risks. Since a European AMC could imply cross-country risk sharing, some financial sector conditionality could be imposed on countries benefiting from it, to make it acceptable to all Euro Area countries.

Another option would be to continue setting up AMCs at the national level. Public support (participation of the State in the capital of the AMC or guarantees granted) may be needed to allow AMCs to buy impaired assets at a sufficiently high price and to reduce risks faced by private investors participating in the capital of AMCs. However, European rules could hinder such public support. Under the new bank recovery and resolution directive (BRRD), selling assets to AMCs above market price is considered state aid, and it triggers the implementation of a restructuring plan for the bank, a “bail-in” of junior creditors (i.e. their financial participation in the recapitalization of the bank) and, since January 2016, possibly a bail-in of senior creditors as well.

In this context, introducing flexibility in EU rules to solve NPLs without triggering bail-in and resolution procedures should be considered. A very high level of NPLs should be considered a serious economic disturbance and warrants a waiver of bail-in and resolution procedures. Alternatively, a more lenient definition of the price level triggering state aid – and hence resolution – could be used.

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