Public funding of failing banks in the European Union (LBF vol. 19) 2020/2.6.2:2.6.2 Asset measures in times of financial difficulties

Public funding of failing banks in the European Union (LBF vol. 19) 2020/2.6.2

2.6.2 Asset measures in times of financial difficulties

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The previous section discussed the funding instruments that are available for banks in times of financial difficulties. These funding instruments address and improve the equity and liabilities side of the balance sheet of a bank in difficulties. There are also measures that help restore the assets side of the balance sheet, hereinafter referred to as asset measures.

It is generally recognised that non-performing assets (NPAs) translate into lower interest income and higher loan loss provisions, eventually leading to a deterioration in banks’ profitability and regulatory capital. It is there fore important that NPAs are identified in a timely way and measured efficiently. In April 2018, the Financial Stability Institute of the BIS recommended to introduce a regulatory definition of NPA, to harmonise NPA entry and exit criteria and to gain powers, if not yet available, to impose prudential backstops (as a downward adjustment in regulatory capital) to deal with situations where accounting provisions on NPAs are deemed inadequate from a supervisory perspective.1 These recommendations followed on the Guidelines on prudential treatment of problem assets of the BIS published in April 2017.

In the EU, a common definition of non-performing exposures (NPE) was introduced in 2014 by the EBA and is based on a combination of ‘past due’ (90 days) and the forward-looking ‘unlikely to pay’ criteria.2 This definition is also used by the Commission in its package to address non-performing loans (NPLs), as mentioned in section 1.4.1.4.

NPLs denote loans where the borrower is unable to make the scheduled payments to cover interest or capital reimbursements. When the payments are more than 90 days past due, or the loan is assessed as unlikely to be repaid by the borrower, it is classified as an NPL.3

NPLs can weigh on bank performance by generating less income. This may reduce the bank’s profitability and, in the most severe cases, jeopardize the viability of a bank. In addition, NPLs tie up significant amounts of a bank’s resources. This reduces the bank’s capacity to lend.4 Accelerating the resolution of NPLs is therefore a top priority for the EU. One of the key policy areas in this context is the development of secondary markets for distressed debt so that banks can deliberately and sustainably reduce NPLs in their balance sheets.5

There is a consensus that Europe is over-banked, and that this is evident in the imbalance between bank assets and relatively under developed capital markets, in the slow progress of bank consolidation and in often unfocused business models that have contributed to low profitability. 6 Creating a secondary market for NPL portfolios may be beneficial to refocusing the business strategy and creating a better balance between bank assets and capital markets (when the investors are outside the banking sector).

This section discusses the asset measures that can be taken to address NPAs on the balance sheet of a failing bank.

2.6.2.1 NPE strategy options2.6.2.2 Member State support2.6.2.3 National resolution funds2.6.2.4 Supranational asset measures

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