How to Make Your Nonperforming Loans Harmless
According to data collected by the European Bank Authority, the non-performing loans to total loans ratio has decreased in the EU since 2014 by nearly three points. However, some member states such as Italy still report high ratios. What to do? Andrea Resti has studied the issue on behalf of the European Parliament's Economic and Monetary Affairs Committee. He has pinpointed four main levers that can be used to drive down non-performing loans (NPL).
The first one is the improvement of the recovery process.
"Banks often lack specialized skills and IT infrastructures. Additionally, an independent unit should operate the workout of defaulted exposures". The second lever is NPL sales. In recent years they have been a substantial volume of sales that allowed Italy to lower its NPL ratio from 16.3% to 9.4%. Sales are not without risks. When large investment funds buy NPL, they look for double-digit rates of return. They therefore buy at low price. The difference between the price and the underlying long-term economic value causes a wealth transfer from the banking system to outside investors.
The third lever is the creation of state supported bad banks that can buy non-performing exposures and wait for a better economic climate to resell them. The fourth lever is the introduction of calendar provisioning: lenders must write down NPL based on a pre-defined schedule. "The idea is to impose on banks a calendar of increasing devaluations that will lead, within a number of years, to total devaluation.
This is what the European Central Bank established, stealing, so to speak, from the European Parliament its law-making role. A similar but less strict rule was later approved by the European Parliament itself. Unfortunately, the rule could act as an incentive to lenders to sell NPL at a price below their long-term economic value".
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