“The price is right”: using auction theory to enhance competition in the NPL market

Abstract

Almost a decade after the onset of the global financial crisis, the stock of non-performing loans (NPLs) still represents a major burden for European banks’ profitability and a severe headwind for credit growth at an area-wide level. While a great deal has been done to establish stricter supervisory rules and more robust insolvency frameworks, the development of an efficient secondary market for impaired assets is currently lagging behind, especially in the countries where the level of troubled loans is more worrisome. To address this problem, the European Banking Authority has recently proposed to set up an EU-backed asset management company (AMC) for the exchange of NPLs. In addition to the difficulties associated with a full compliance of a public AMC with EU State aid rules, we argue that such a vehicle might be useful in solving just one of the three failures typically affecting the market for NPLs, that is the information asymmetry between buyers and sellers. To successfully tackle the other two—namely, market power and collusion—a correct design of the market is crucial. From this point of view, auction theory can be of great help.