| Author (Corporate) | European Parliament: European Parliamentary Research Service |
|---|---|
| Publisher | EU |
| Series Title | In-Depth Analysis |
| Series Details | October 2017 |
| Publication Date | October 2017 |
| Content Type | Report |
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Provisioning policies for non-performing loans: How to best ensure a 'clean balance sheet'? (1) The paper explains the accounting mechanics regarding loan loss provisions (LLP) and introduces the three most important models for loan loss provisioning: the incurred loss model (ILM), the expected credit loss model (ECL) and the counter-cyclical buffer model (CBM). The paper investigates the preferred method to calculate loan loss provisions that from the viewpoint of financial accounting needs (information needs of financial statement readers) and prudential regulation (micro and macro prudential supervision). Based on economic reasoning the expected loss model is shown to be the preferred model for both purposes. The new IFRS 9 accounting standard is a mixture between the current incurred loss model and the expected credit risk model while the American standard setter FASB has introduced a pure version of the expected credit loss concept in the United States. The paper urges a convergence of IFRS 9 towards the FASB model. The paper investigates the key differences between the LLP concepts as they are currently used and applied in accounting and prudential supervision. It argues that both financial accounting and banking supervision should be based on a harmonized concept for LLP calculation in the future. The proposed transition rules of the EU commission should be adapted in order to prevent unwarranted increases of regulatory capital. Provisioning policies for non-performing loans: How to best ensure a 'clean balance sheet' (2) This note provides an updated picture on NPLs in the European Union, showing that – although the NPL ratio has been steadily decreasing, significant differences remain across Member States. It then discusses the two main factors driving NPLs in the long term: the macroeconomic cycle and the banks’ lending practices, arguing that policy makers should continue to encourage the development of sound internal credit ratings. Finally, four main levers are discussed, that can be used to curb high NPL stocks. Internal recovery processes, which should be improved by investing in better IT architectures and specialised professional skills. NPL sales, which may prove attractive (and reduce the supervisors’ own reputational risks), but also to destroy value for bank shareholders, debtholders and the public purse. Asset management companies (AMCs), which may prevent banks from disorderly liquidating NPLs, force badly-managed banks to feel the pain of past mistakes and gradually recover loans while being funded at an acceptable cost. Calendar provisioning regimes like the one recently proposed by the SSM, which may force banks to quickly write down non performing exposures, but may suffer from several drawbacks and should be enacted through a fully-fledged, accountable political process. In designing ways to tackle non-performing exposures, one should never forget that NPLs, while being associated with modest profits and poor loan supply, do not cause them but, like them, follow from poor real growth, ineffective management and faulty governance schemes. Provisioning policies for non-performing loans: How to best ensure a 'clean balance sheet'? (3) New provisioning rules introduced by IFRS 9 are expected to reduce the procyclicality of provisioning. Heterogeneity among banks in the procyclicality of provisioning may not only reflect the formal accounting rules, but also variation in discretionary provisioning policies. This paper presents empirical evidence on the heterogeneity of provisioning procyclicality among significant banks that are directly supervised by the ECB. In particular, this paper finds that provisioning is relatively procyclical at banks that have i) high loans-to-assets ratios, ii) high shares of non-interest income in total operating income, iii) low capitalization rates, and iv) low total assets. Supervisory guidance provided to banks on how to implement IFRS 9 has mostly been of a qualitative nature, and may prove inadequate to prevent an undesirably wide future variation in provisioning among EU banks. Provisioning policies for non-performing loans: How to best ensure a 'clean balance sheet' (4) Non-performing loans (NPLs) are still an important problem in Europe, in particular in the euro area. Provisioning is one way to address such a problem. Although coverage ratios have been increasing in recent years, banks’ provisioning policies are quite different across banks and countries. Various reasons, ranging from different collateral characteristics and enforcement systems to tax regimes, accounting methods, managerial and supervisory practises, contribute to explain the observed differences. Recent measures aimed at increasing transparency and disclosure rules and the adoption of new accounting rules are an important step forward. They have to be complemented, however, by appropriate early intervention measures and effective supervisory power.Four separate studies prepared for European Parliament Committee on the theme of Provisioning policies for non-performing loans (NPLs). |
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| Subject Categories | Business and Industry |
| Countries / Regions | Europe |
