08 March 2021

ECON Brief: Non-performing Loans - New risks and policies? - What factors drive the performance of national asset management companies?

This paper develops, on the basis of a cost-benefit analysis, on the conditions that must be met for an Asset Management Company (AMC), established under the centralised approach in EU Member States, to efficiently facilitate the management and recovery of non-performing loans (NPLs).

It concludes that public AMCs, even if optimally designed, should not be viewed as a ‘panacea’ but as one of several measures that can be taken to address the NPL problem and prevent bank failures.

The aim of this paper is to develop on the institutional, governance and (to a certain extent) operational conditions that must be met for a public Asset Management Company (AMC), established under the so-called centralised approach in an EU Member State, to be able to efficiently facilitate the management and recovery of non-performing loans (NPLs), taking, in particular, account of the impact of the COVID-19 pandemic crisis.

The paper is structured in four Sections:

Section 1 discusses the historical dimension of the NPL problem in the EU before the onset of the pandemic crisis (legacy NPLs) and the measures taken to address it, the characteristics, legal definition and regulatory implications of NPLs and non-performing exposures (NPEs) and the impact of the pandemic crisis, briefly presenting the measures taken by the European Central Bank (ECB) and the European Banking Authority (EBA) and the European Commission’s 2020 NPL Action Plan.

The relatively longer Section 2 firstly analyses, on the basis of a detailed literature review, the alternative approaches for setting up AMCs, the objectives, operational goals and structural issues of public AMCs established under the centralised approach, developing on their advantages and disadvantages, specific inherent incentive issues, as well as the conditions leading to the efficiency of AMCs as a tool to facilitate NPL management and recovery. This synthesis and, in particular, the cost-benefit analysis undertaken to identify advantages and disadvantages, allows the author to submit proposals on certain specific conditions for the efficient operation of national, public AMCs in the EU.

The first interim conclusion is that public AMCs set up in Member States under the centralised approach can, indeed, be efficient tools for facilitating NPL management and recovery, albeit upon the existence of a robust legal framework, which should clearly define, inter alia, their primary and secondary objectives, including social ones, specific safeguards of their operation, their limited lifespan. AMCs should be subject to the prudential supervision of national competent authorities (NCAs) as financial (not credit) institutions and their independence, transparency and, most importantly, corporate governance should also be embedded in the legal framework. Furthermore, appropriate policies regarding the selection of assets to be transferred and the pricing of such assets and sound strategic plan reviews for asset recovery should be in place, which would support the managerial factor, appropriately structured incentives and the commercial orientation of its operations.

Section 3 briefly presents other alternative measures and policies existing next to national AMC, such as the creation of an AMC at EU level, systematic securitisation-based schemes for NPLs and the precautionary recapitalisation of credit institutions by public funds, as laid down in the EU regulatory framework governing banking resolution, with due reference to selected recent academic studies and the proposals in the European Commission’s 2020 NPL Action Plan. This leads to the second interim conclusion that resort to all these alternatives should carefully be considered on an ad hoc basis, duly taking account of merits and relative disadvantages on the basis of criteria such as effectiveness, feasibility and credibility.

Finally, Section 4 discusses the bigger picture, developing on the role of supervisory and resolution authorities in preserving financial stability, the ultimate public policy objective, in view of the emerging new wave of NPLs due to the current pandemic crisis. The author argues that in this respect, of primary importance are the quality of prudential banking supervision and the (closely related issue of) monitoring credit institutions’ own credit risk management policies, in particular in relation to the provision of new credit and loans to households and businesses. In this respect it is also noted that in several cases, corporates may be rather in need of own funds to increase their solvency, which cannot be covered by bank lending, which must also be taken into account in the context of credit risk management. In addition, of relevance are the EU-wide stress test exercises of credit institutions’ portfolios to be conducted in 2021, the appropriate use by the ECB and NCAs, if necessary, of their specific supervisory and early intervention powers, as well as their (supervisory) approach to consolidation in the EU banking sector. Finally, another important element towards the preservation of financial stability is the progress to be further made in relation to resolution planning to attain the resolvability of credit institutions, including the build-up of minimum requirements for own funds and eligible liabilities (MREL).

In making his final concluding remarks the author notes that public AMCs, even if optimally designed, should not be viewed as a ‘panacea’ but as one of several measures that can be taken in order to address the NPL problem and prevent the adverse scenario where one or (more importantly) several credit institutions would reach the point of meeting the ‘failing or likely to fail’ criterion laid down in the EU resolution framework due to their exposure to NPLs. In such a case, it (or they) should either be resolved or wound up under normal insolvency proceedings.

Full paper

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