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Bad debt classification practices across Europe show “material differences that, if not considered, would severely affect the consistency and credibility of the exercise", according to the undated document obtained by Bloomberg News. A person familiar with the text said it was drawn up in late November and contains the ECB’s latest thinking on the subject.
The Frankfurt-based ECB is conducting a three-stage assessment of bank assets before it assumes oversight of about 130 lenders across the 18-member euro area this November. Using a strict definition of bad debt could threaten banks in countries hit hardest by Europe’s debt crisis, while a laxer rule may not reveal the true condition of the region’s financial system. “A more ambitious definition would be consistent with the need to convey to external observers that the AQR is a thorough exercise", the document said, referring to the Asset Quality Review stage of the Comprehensive Assessment. That’s set to culminate with a stress test run in cooperation with the European Banking Authority before October this year.
The ECB document said that not all countries may be able to comply with simplified definitions of non-performing loans set out in October by the London-based EBA, the EU’s top bank regulator, while saying that alignment to those rules is “of the essence".
The ECB signalled it would apply the EBA’s simplified definition as a minimum, and where possible increase the level of detail on loans made by banks. While the simplified EBA rules should be adhered to in the Comprehensive Assessment as a minimum, adding further detail to the assessment could be possible since ECB officials will already be in contact with bank staff, the document said.
“Given the possibility to perform more granular analysis during the on-site visits, it is proposed that this analysis takes into account a more ambitious definition including the unlikeliness to repay criterion", according to the document.