Abstract
In March 2018, the ECB published “Addendum to the ECB Guidance to banks on non-performing loans: supervisory expectations for prudential provisioning of non-performing exposures” in which it required non-performing loans originated after 1 April 2018 to be fully written down after 7 years, with unsecured loans to be written offer after only 2 years. In practice, this approach implies the use of a null value: i) after seven years for secured non-performing loans and ii) after two years for unsecured loans, with an accounting provision for an equivalent amount. European Banking Authority (EBA) statistics for 2019 show that provisions for non-performing loans in Europe were 44.9% (Note 1), corresponding to an NPL valuation of 55.1%, which is higher than the implicit value in the prudential provisions recommended by the ECB. The ECB's new guidelines on provision levels and the implicit value of such provisions creates serious doubt about banks' estimated fair values of NPLs, as per what they book in their accounts. This article aims to use the disclosures provided by listed Italian banks in their notes to the accounts from 2009 to 2019 to determine if the fair value for NPLs, as divided between the secured part and the unsecured part, is value relevant and the amount of any discount/premium applied by the financial market compared to the actual fair value that is booked. The results highlight the excessively prudential nature of completely writing off non-performing loans and justify a review of the approach adopted by the European Council and Parliament in August 2019 (and subsequently adopted by the European Central Bank) in which unsecured NPLs should be fully written off after 3 years (compared to 2 years before), NPLs secured by real estate after 9 years (compared to 7 years before) and NPLs secured by non-real estate guarantees after 7 years (confirming the previous approach) for all loans originated after 26 April 2019.
Highlights
In March 2017, the European Central Bank published "Guidance to banks on non performing loans" setting out its supervisory expectations for managing the entire life cycle of non-performing loans, from the time they are classified as such and booked in the accounts, to the strategy for managing them
In March 2018, the ECB published “Addendum to the ECB Guidance to banks on non-performing loans: supervisory expectations for prudential provisioning of non-performing exposures” in which it required loans originated after 1 April 2018 to be fully written down after 7 years, with unsecured loans to be written off after only 2 years
This study, using the information disclosed by Italian banks in the notes to the balance sheet for the fair value of secured and unsecured non-performing loans, showed that the implicit value in stock market prices for secured non-performing loans is roughly 4% below the published book value
Summary
In March 2017, the European Central Bank published "Guidance to banks on non performing loans" setting out its supervisory expectations for managing the entire life cycle of non-performing loans, from the time they are classified as such and booked in the accounts, to the strategy for managing them (sold on the market, or managed internally). For the nature of the guarantee and loan vintage, in October 2017, the European Central Bank published an addendum to it guidance for banks on non-performing loans in which it details the minimum prudential provision levels for NPLs. The document was part of the consultation process and it indicated a prudential provision of 100% of the value of the NPE by:. "In this context, BMPS is recommended to implement, over the few years (up to the end of 2026) a gradual increase in coverage levels on the stock of non-performing loans outstanding at the end of March 2018, according to a complementary approach with the indications set, in the Addendum to the ECB Guidance to Banks on non-performing loans, for NPL flows generated starting from April 2018." (Source: Banca Monte dei Paschi di Siena press release on 11 January 2019). O Should the coverage not meet the regulatory requirements, measures that have an impact on the bank's capital would need to be considered
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