|
|
The current Eurozone crisis is a stark reminder of the dangers posed to economic and financial stability by over-indebtedness, under-provisioning and NPLs. But as authors have documented, the NPL situation facing Europe today is not unprecedented. Indeed it bears more than a passing resemblance to past crises in, inter alia, Latin America in the 1980s and Japan in the 1990s where protracted debt crises resulted in ‘lost decades’.
Ultimately it is poor lending, rather than accounting or reporting, that causes financial crises. However, the timely recognition of problem loans and credit loss by banks, and proper transparency such that asset positions are well-understood by the market, regulators and others,
is critical in assessing how to avert or mitigate crises. As they have seen, banks can be incentivised by accounting, regulatory and tax considerations in various ways when considering how to identify, and provide against, problem loans. This in turn can result in under-provisioning, particularly when the economic environment is relatively benign. But the early recognition of expected losses in good times is generally agreed by policymakers to contribute to greater bank resilience and mitigate the impact of crises on banks’ balance sheets. This in turn lowers the probability of downturns resulting in debt crises that last several years or even decades.
But even before considerations of provisioning, problem loans need to be identified according to criteria that are transparent, understandable and economically meaningful, and there is currently no universal consensus as to what these criteria should be. The introduction of expected loss provisioning methodologies that require loans to be classified into different categories adds further to the need for more understandable methods of asset quality classification, in order to provide adequate context for these provisions to be understood. Understanding the nature and quality of bank assets remains the key to assessing the health of the banking system as a whole, and transparency in this area is therefore key to financial stability.