|
|
The resolution of non-performing loans (NPLs) that have reached systemic levels is complex and costly. Bank NPL problems tend to emerge after credit booms or protracted periods of low growth in structurally weak financial systems. NPLs crowd out new lending, eroding both the profitability and solvency of banks. When high NPL levels affect a sufficiently large number of banks, the financial system stops functioning normally, and banks can no longer provide credit to the economy. A prompt recovery can be obstructed by impaired market functioning and coordination failures among banks. In such circumstances, authorities usually step in to lead the crisis response. To this end, they can deploy a variety of resolution instruments, although these typically require a large amount of resources and take time to deliver results.
This paper draws on several country cases and extracts some practical insights about the success factors behind specific NPL resolution strategies. This study suggests that the resolution toolkit used by the authorities has remained broadly unchanged for several decades, based on authors‘ review of recent NPL build-ups in Europe and the United States, as well as earlier examples such as the Asian and Nordic financial crises of the 1990s, and the US savings and loan (S&L) crisis in the 1980s. However, the success of resolution policies varies from case to case, and the paper identifies a few factors that determine the feasibility of individual resolution policies. Such characteristics include macroeconomic and structural banking sector conditions, the type of problem assets, the fiscal space for public sector intervention, and legal and judicial frameworks for NPL resolution. These country-specific characteristics determine how far specific resolution options may be applicable and effective in one country but not in another.
The paper matches the instruments in the NPL resolution toolkit to countries’ key characteristics, and identifies constraints and possible solutions. The paper discusses the advantages and disadvantages of individual resolution tools, drawing on country cases that shed light on how such tools have been used, and what constraints authorities faced in their application. Next, the paper matches the resolution tools to the key country characteristics, to identify how such characteristics help to define the policy space for NPL resolution. In some cases, country characteristics do not constrain the applicability of the whole NPL resolution toolkit, simplifying the official response, while in others the set of resolution options is more restricted.
Three main lessons can be helpful in designing a response to a crisis or a medium-term strategy for crisis preparedness. First, recognising the constraints that country-specific characteristics impose on resolution policies and the associated trade-offs can help authorities select the most successful policies. Second, with time, authorities can expand their resolution toolkit, by taking stock of any hindrances to specific NPL resolution policies and considering measures to remove them. Third, NPL resolution interacts with other policies during a crisis. Macroeconomic and macroprudential policies can mitigate NPL problems, but do not represent an alternative to dealing with the underlying NPLs. Clear communication helps to pave the way for a successful resolution policy and to establish a reference point for its ex post assessment.