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Most NPLs are legacy issues. European banking supervision has, so to speak, inherited them. It’s a major problem that needs to be tackled.
For banks, the non-performing loans weigh on profits; they require provisioning, and they are a constant drain on banks’ human resources, which could be put to more profitable use. And NPLs undermine trust – to what extent do markets trust a bank with a balance sheet that is considerably impacted by NPLs? In other words, non-performing loans make the affected banks weaker and keep them from lending to the economy.
Now is the time to sort out the issue of non-performing loans. Banks need ambitious yet realistic plans to deal with their stocks of NPLs. And they need the right governance for these plans.
Banks have to carefully consider how they will react should any performing loans happen to become non-performing. So, with the future in mind, it is needed to ensure that the problem of NPLs does not recur. New NPLs should therefore be conservatively provisioned within a reasonable period of time. This would serve to strengthen the balance sheets of banks, enabling them to focus on their core business.
That’s why ECB has drafted an addendum to its guidance on non-performing loans. It sets out how ECB expects banks to provision for future NPLs. The main goal is to have timely provisioning, which should prevent new NPLs from becoming a problem with systemic implications.
The addendum to ECB‘s guidance on non-performing loans explains ECB‘s methodology and is currently the subject of a public consultation. This consultation will increase transparency for banks, and the public, and it will help to ensure a level playing field. So, while it is ultimately up to the banks to deal with NPLs, supervisors play a role too. It is their job to address vulnerabilities in the banking sector. NPLs are probably the single biggest challenge – and of course they are a drag on the entire economy.