Hundred euros sinkingThe European Central Bank (ECB) has launched a public consultation on its guidance to banks on handling non-performing loans (NPLs), which is open until 15 November 2016. The ECB has also published the first stocktake of national supervisory practices and legal frameworks concerning NPLs.

The draft NPL guidance to banks, which is available on the ECB Banking Supervision website, addresses recommendations regarding strategy, governance and operations, which are key to handling NPLs and sets out a number of best practices that the ECB has identified and that will constitute the ECB’s supervisory expectations going forward.

The NPL guidance is addressed to credit institutions within the meaning of Article 4(1) of Regulation (EU) 575/2013. It is therefore generally applicable to all significant institutions supervised directly under the Single Supervisory Mechanism, including their international subsidiaries. Therefore, the ECB is focusing on asset quality as the key priority for its banking supervision, which comprises of two main pillars – an asset quality review and a stress test. Following on from the comprehensive assessment the ECB has done recently, the ECB is now intensifying its supervisory attention and work on NPLs.

The NPL guidance is structured to follow the life cycle of NPL management.  The contents include the following chapters-
1. Introduction
2. NPL strategy
3. NPL governance and operations
4. Forbearance
5. NPL recognition
6. NPL provisioning and write-offs
7. Collateral valuations.

The NPL guidance recommends that banks with a high level of NPLs should establish an internal business strategy which needs to be combined with their future business plan and risk management framework to effectively manage and ultimately reduce their NPL portfolio in a credible, feasible and timely manner. The banks’ business strategies should include the setting of quantitative targets to reduce the NPL portfolio and a detailed implementation plan. Further, the NPL guidance recommends banks to put in place appropriate governance and operations structures to deliver an effective NPL reduction and workout. The strategy should be done by closely involving the banks’ management, setting up dedicated NPL workout units and establishing clear business policies which need to be linked to NPL reductions and workouts. Therefore, the NPL guidance provides for the banks’ short-term and long-term options and solutions with the aim of returning the exposure to a state of sustainable repayment. It further guides banks on how to measure impairment and write-offs in line with international recommendations. The NPL guidance outlines the policies, procedures and disclosures banks should adopt when valuing immovable property held as collateral for NPLs.

Currently, the NPL guidance is of a non-binding nature, but ECB will expect the banks to explain and substantiate any deviations upon supervisory request and any non-compliance may trigger supervisory measures. When implemented, banks will be expected to apply the NPL guidance proportionately and with appropriate urgency. The NPL guidance will be finalized following the consultation process and the final document will be published in the next few months.

However, the NPL guidance does not intend to substitute or supersede any applicable regulatory or accounting requirement or guidance from existing EU regulations or directives and their national transpositions or equivalent, or guidelines issued by the European Banking Authority. It should be noted that the NPL guidance is a supervisory tool with the aim of clarifying the supervisory expectations regarding NPL identification, management, measurement and write-offs in areas where existing regulations, directives or guidelines are not existing or do not provide clarity. Where binding laws, accounting rules and national regulations on the same topic exist, the banks should comply with those.

The ECB will hold a public hearing as part of this consultation at 15.00 CET on 7 November 2016, at its premises in Frankfurt. The hearing will be webcast on the ECB’s Banking Supervision website. Information on registering for the public hearing and on how to submit comments can also be found here. Following the public consultation the ECB will publish the received comments, together with responses and an assessment of the comments.