COMMISSION STAFF WORKING DOCUMENT IMPACT ASSESSMENT Accompanying the document Proposal for a Regulation of the European Parliament and of the Council amending Regulation (EU) No 575/2013 as regards minimum loss coverage for non-performing exposures
Date: 2018-03-14
Institutions: Directorate-General for Financial Stability, Financial Services and Capital Markets Union, European Commission
Subjects: EU banking union, action programme, bank, banking supervision, banking system, capital market, credit policy, financial risk, financial solvency, loan

EN 

  EN 

   EUROPEAN COMMISSION  Brussels, 14.3.2018  SWD(2018) 73 final  COMMISSION STAFF WORKING DOCUMENT  IMPACT ASSESSMENT  Accompanying the document Proposal for a Regulation of the European Parliament and of the Council amending Regulation (EU) No 575/2013 as regards minimum loss coverage for non-performing exposures {COM(2018) 134 final}  - {SWD(2018) 74 final}  
 
 
Table of contents 

1. 

INTRODUCTION: POLITICAL AND LEGAL CONTEXT ............................................................... 5 

BACKGROUND INFORMATION ON LOAN LOSS PROVISIONING ................................................... 12 

2. 

PROBLEM DEFINITION .................................................................................................................. 15 

3.  WHY SHOULD THE EU ACT? ........................................................................................................ 27 

4.  OBJECTIVES: WHAT IS TO BE ACHIEVED? ............................................................................... 29 

5.  WHAT ARE THE AVAILABLE POLICY OPTIONS? .................................................................... 31 

6.  WHAT ARE THE IMPACTS OF THE POLICY OPTIONS? ........................................................... 41 

7.  HOW DO THE OPTIONS COMPARE? ............................................................................................ 54 

8. 

PREFERRED OPTION ...................................................................................................................... 56 

9.  HOW WILL ACTUAL IMPACTS BE MONITORED AND EVALUATED? .................................. 57 

ANNEX 1: PROCEDURAL INFORMATION ............................................................................................ 58 

1. 

LEAD DG, DECIDE PLANNING/CWP REFERENCES .................................................................. 58 

2.  ORGANISATION AND TIMING ...................................................................................................... 58 

3. 

4. 

CONSULTATION OF THE RSB ....................................................................................................... 58 

EVIDENCE, SOURCES AND QUALITY ......................................................................................... 58 

ANNEX 2: STAKEHOLDER CONSULTATION ....................................................................................... 60 

1. 

2. 

TARGETED CONSULTATION ........................................................................................................ 60 

EXPERT  GROUP  ON  BANKING,  PAYMENTS  AND 
MEETINGS ........................................................................................................................................ 63 

INSURANCE 

(EGBPI) 

ANNEX 3: WHO IS AFFECTED AND HOW? .......................................................................................... 65 

ANNEX  4:  PROVISIONING  RULES  FOR  PROBLEM  LOANS  ACROSS  THE  GLOBE  – 

OVERVIEW ....................................................................................................................................... 67 

REFERENCES ............................................................................................................................................. 75 

1 

 
 
 
Glossary and list of abbreviations 

Term or acronym 

Meaning or definition 

Accelerated Extrajudicial Collateral 
Enforcement (AECE) 

Measures  to  enhance  the  protection  of  secured  creditors  by  allowing  them 
more efficient methods of value recovery from secured loans. 

Asset Management Company (AMC) 

Asset Quality Review (AQR)  

A  special-purpose  vehicle  for  cleansing  bank  balance  sheets.  A  credit 
institution  can  transfer  non-performing  assets  (NPA)  to  an  AMC,  subject  to 
certain requirements and conditions being met. AMCs are often referred to as 
“bad banks”. 

Assessment  conducted  by  supervisors  to  enhance  the  transparency  of  bank 
exposures, including the adequacy of asset and collateral valuation and related 
provisions. 

BU 

Banking Union 

Basel Committee on Banking 
Supervision (BCBS) 

Committee of the Bank for International Settlements which provides a forum 
for  regular  cooperation  on  banking  supervisory  matters.  Its  objective  is  to 
enhance  understanding  of  key  supervisory  issues  and  improve  the  quality  of 
banking  supervision  worldwide.  The  most  important  regulatory  frameworks 
are  known  as  Basel  II  and  Basel  III.  Representatives  of  central  banks  and 
supervisory authorities from different countries are members of the BCBS. 

CMU 

Capital Markets Union 

Capital Requirements Regulation 
(CRR) 

Regulation (EU) No 575/2013 of the European Parliament and of the Council 
of  26  June  2013  on  prudential  requirements  for  credit  institutions  and 
investment firms and amending Regulation (EU) No 648/2012.  

Capital Requirements Directive IV 
(CRD IV) 

Common Equity Tier 1 (CET1) 
capital 

Competent Authority (CA) 

Directive  2013/36/EU  of  the  European  Parliament  and  of  the  Council  of  26 
June  2013  on  access  to  the  activity  of  credit  institutions  and  the  prudential 
supervision  of  credit  institutions  and  investment  firms,  amending  Directive 
2002/87/EC and repealing Directives 2006/48/EC 
and 2006/49/EC. 

The highest quality form of regulatory capital ("own funds") under CRR/CRD 
IV which implement Basel in the EU. 
It includes common equity shares (ordinary shares) and related share 
premium, accumulated other comprehensive income, retained earnings 
together with most other equity reserves, less prudential adjustments and 
deductions.  

A  public  authority  or  body  officially  recognised  by  national  law,  which  is 
empowered by national law to supervise institutions as part of the supervisory 
system in operation in the Member State concerned. 

Non-performing loans coverage ratio 
(CovR) 

Loan loss provisions for loans and advances to customers as a percentage of 
non-performing loans and advances to customers. 

Cure rate (CR) 

EBA 

ECB 

The  percentage  of  loans  that  previously  presented  arrears  and,  post 
restructuring, present no arrears. 

European Banking Authority 

European Central Bank 

ECOFIN Council 

Economic and Financial Affairs Council 

ESRB 

European Systemic Risk Board 

Expected loss (EL)  

The ratio of the amount expected to be lost on an exposure from a potential 
default  of  a  counterparty  or  dilution  over  a  one-year  period  to  the  amount 
outstanding at default. 

2 

 
 
 
Exposure 

EP 

FED 

Forbearance 

Foreclosed assets 

Asset (e.g. a loan) or off-balance-sheet item (e.g. guarantee). 

European Parliament 

Federal Reserve Board 

Forbearance measures are concessions towards debtors facing, or about to 
face, difficulties in meeting their financial commitments.  

For the purposes of this document, foreclosed assets are defined as assets held 
on  the  balance  sheet  of  a  credit  institution  obtained  by  taking  possession  of 
collateral,  or  by  calling  on  similar  credit  enhancements.  Those  assets can  be 
obtained through judicial procedures (“foreclosed” in the strict sense), through 
bilateral agreement with the debtor (swap or sale) or other types of collateral 
transfer  from  debtor  to  creditor.  Foreclosed  assets  comprise  both  financial 
assets  and  non-financial  assets.  Foreclosed  assets  include  all  collateral 
obtained  irrespective  of  their  classification  for  accounting  purposes  (e.g. 
including assets for own use and for sale). 

FSC 

GDP 

Financial Services Committee 

Gross domestic product 

International Accounting 
Standards (IAS) 

Rules  set  by  the  International  Accounting  Standards  Board  (IASB)  –  an 
independent  body  of  international  accounting  experts.  The  main  purpose  of 
the standards is to promote the quality, transparency and comparability – at an 
international  level,  too  –  of  financial  statements  drawn  up  by  various 
enterprises  or  by  one  enterprise  for  various  periods.  Publicly  traded 
enterprises domiciled in the EU are required by Regulation (EU) 1606/2002 to 
prepare  consolidated  financial  statements  in  accordance  with  International 
Accounting  Standards.  As  the  IASB  is  an  international  association  under 
private  law,  its  standards  cannot  be  immediately  legally  binding.  Each 
standard  has  to  undergo  a  recognition  procedure  in  order  to  become  legally 
binding at EU level or in other countries. Prior to 1 April 2001, the body was 
called  the  International  Accounting  Standards  Committee  (IASC)  and  the 
rules  that  it  issued  were  called  International  Accounting  Standards  (IAS). 
These rules are still valid and still bear the same name. Any rules published 
after this date are called International Financial Reporting Standards (IFRS). 

International Financial Reporting 
Standards (IFRS) 

Set  of  international  accounting  standards  stating  how  particular  types  of 
transactions and other events should be reported in financial statements. 

IMF 

Loss 

International Monetary Fund 

Economic  loss,  including  material  discount  effects,  and  material  direct  and 
indirect costs associated with collecting on the instrument. 

Loss given default (LGD)  

The ratio of the loss on an exposure due to the default of a counterparty to the 
amount outstanding at default. 

Loan loss provision (LLP) 

Reduction  in  the  carrying  amount  of  an  asset  to  reflect  its  decrease  in 
creditworthiness. 

Loan to value (LTV) 

Ratio used in the context of mortgage lending expressing the value of a loan 
compared to the appraised value of the underlying real estate. 

MS 

Member State 

Non-performing assets (NPAs)  

The sum of NPEs and foreclosed assets. 

Non-performing exposure (NPE) 

An  exposure  (i.e.  a  loan,  debt  security  or  off-balance-sheet  item)  that  is  not 
held  for  trading  purposes  and  that  satisfies  at  least  one  of  the  following 
criteria: 
(a) it is material and more than 90 days past-due; 
(b)  the  debtor  behind  the  exposure  is  assessed  as  unlikely  to  pay  his/her 

3 

 
 
 
 
 
 
Non-performing loan (NPL) 

obligation  in  full  without  selling  the  collateral  guaranteeing  the  exposure  (if 
any). 

NPEs include defaulted and impaired exposures1.  

A loan that is not held for trading purposes and that satisfies at least one of the 
following criteria: 
(a) it is material and more than 90 days past-due; 
(b) the debtor is assessed as unlikely to repay the loan in full without selling 
the collateral guaranteeing the exposure (if any). 

Non-performing loans include defaulted and impaired loans2. 

NPL ratio 

The  ratio,  expressed  in  percent,  between  the  amount  of  NPLs  and  the  total 
amount of bank loans. 

Probability of default (PD) 

The probability of default of a counterparty over a 1-year period. 

Performing exposure (PE)  

An exposures that does not meet the criteria to be considered an NPE. 

Recovery Rate (RR) 

Measures the extent to which the creditor recovers the principal and accrued 
interest due on a defaulted debt. 

Significant institution (SI) 

In the context of the SSM (see below), a bank that meets any of the following 
criteria: 
(a)  it  is  one  of  the  three  largest  banks  in  a  MS  participating  in  the  Single 
Supervisory Mechanism; 
(b) it received direct assistance from the European Financial Stability Facility/ 
the European Stability Mechanism (EFSF/ESM) assistance; or 
(c)  it  has  total  assets  in  excess  of  €30  billion  or  20%  of  national  gross 
domestic product (with a balance sheet total of at least €5 billion). 
In exceptional cases, the ECB can declare significant a bank operating across 
national borders. 
If  a  bank  is  identified  as  a  significant  institution,  it  is  subject  to  direct 
supervision of the ECB. 

SME 

Small- and medium-sized enterprise 

Single Supervisory Mechanism 
(SSM) 

The pillar of the BU that is responsible for banking supervision. It comprises 
the ECB and the national supervisory authorities of the participating countries. 
Its  main  aims are  to:  (i)  ensure  the  safety  and  soundness  of  the  EU  banking 
system, (ii) increase financial integration and stability, (iii) ensure consistent 
supervision. 

Single Supervisory Mechanism 
Regulation (SSMR)  

Council  Regulation  (EU)  No  1024/2013  conferring  specific  tasks  on  the 
European  Central  Bank  concerning  policies  relating  to  the  prudential 
supervision of credit institutions. 

Stress test (ST)  

An  exercise  conducted  by  supervisory  authorities  in  order  to  provide 
supervisors,  banks  and  other  market  participants  with  a  common  analytical 
framework  to  consistently  compare  and  assess  the  resilience  of  banks  to 
economic shocks. 

TFEU 

Treaty on the Functioning of the European Union 

Unlikeliness to pay (UTP) 

The probability that an obligor will not repay his/her debt in full. 

1 See also Implementing Regulation (EU) No. 680/2014 on Supervisory Reporting 
2 See also Implementing Regulation (EU) No. 680/2014 on Supervisory Reporting 

4 

 
 
 
 
 
 
 
 
                                                            
1. 

INTRODUCTION: POLITICAL AND LEGAL CONTEXT 

1.1.  The need to address NPLs in Europe 

Following the financial crisis, the regulatory framework for banks has changed substantially. The 
European Union has taken the lead in implementing reforms agreed globally at the level of the 
G20  and  in  the  Basel  Committee  with  the  objective  of  reducing  risk  in  the  banking  sector, 
reinforcing  financial  stability  and  avoiding  that  taxpayers  have  to  contribute  financially  to  the 
costs  of  failing  banks.  In  addition  to  these  measures,  the  institutional  arrangements  for  the 
supervision  and  resolution  of  banks  in  the  EU  have  been  strengthened  fundamentally  with  the 
establishment  of  the  first  two  pillars  of  the  Banking  Union  (BU):  the  Single  Supervisory 
Mechanism (SSM) and the Single Resolution Mechanism (SRM).3 As a result of these measures, 
the EU banking sector is in a much better shape today than in previous years.  

Nevertheless, several challenges remain to be addressed, including how to decisively address the 
high stocks of non-performing loans (NPLs) and other non-performing exposures (NPEs)4. NPLs 
have piled up in parts of the EU banking sector in the aftermath of the financial and sovereign 
crises and ensuing recessions. High levels of NPLs in parts of the banking sector pose significant 
risks to financial stability and the overall economy in the EU, unlike in other major economies 
such as the United States or Japan which have previously taken a number of actions to reduce the 
level of NPLs and repair banks’ balance sheets.5  

High NPL ratios6 can weigh on a bank's short- and longer-term performance through two main 
channels.  First,  NPLs  generate  less  income  than  performing  loans  –  thus  reducing  bank 
profitability  –  and  may  cause  losses  that  diminish  the  bank's  capital.  In  the  most  severe  cases, 
these effects can put in question the viability of a bank with potential implications for financial 
stability.  Second,  NPLs  tie  up  significant  amounts  of  a  bank's  resources,  both  human  and 
financial.7  Banks  saddled  with  high  levels  of  NPEs  have  therefore  only  a  limited  capacity  to 
provide  new  credit  to  viable  businesses.  Small  and  medium-sized  enterprises  (SMEs)  are 
particularly affected by the reduced credit supply, as they rely on bank lending to a much greater 
extent than larger companies, thereby affecting economic growth and job creation.8 For all these 
reasons,  the  Commission  has  for  a  long  time  highlighted  the  urgency  of  taking  the  necessary 
measures to address the risks related to NPLs.  

While tackling NPLs is primarily the responsibility of national authorities9, there is also a clear 
EU dimension of the NPLs issue. Given the high level of economic and financial integration in 
the EU, and especially within the euro area (EA), there are important potential spill-over effects 
from Member States with high levels of NPLs to the economies of other Member States and the 
EU  at  large,  both  in  terms  of  economic  growth  and  financial  stability.10  Weak  growth  in  some 
Member States due to elevated NPL levels might affect economic growth elsewhere. Also, weak 

3  The  third  pillar  of  the  Banking  Union,  the  European  Deposit  Insurance  Scheme  (EDIS),  was  proposed  by  the 
Commission in November 2015. 
4  NPEs  include  non-performing  loans  (NPLs),  non-performing  debt  securities  and  nonperforming  off-balance-sheet 
items. NPLs, which term is well established and commonly used in the policy discussion, represent the largest share of 
NPEs. Throughout this document the term NPL is meant in a broad sense equivalent to NPE, and hence the two terms 
are used interchangeably. 
5 See, for example, FSC (2017) and IMF (2015c). 
6 The term NPL ratio refers to the ratio of non-performing loans to total outstanding loans. 
7  A large portion of the employees' time is spent dealing with lengthy procedures required to manage NPLs. As NPLs 
are  considered  riskier  than  performing  loans,  they  may  require  higher  amounts  of  regulatory  capital  if  left  un-
provisioned. 
8 Simulations by the IMF (2015b) suggest that a reduction of European Non Performing Loans to the historical average 
ratio  (by  selling  them at  net  book  value  i.e. after  provisioning)  could  increase bank  capital  by EUR  54  billion.  This 
would under some assumptions enable EUR 553 billion in new lending. 
9 As also underlined in the European Semester recommendations to relevant Member States. 
10 See ESRB (2017) and IMF (2015b). 

5 

 
                                                            
balance sheets of just a few banks can negatively affect investors' general perception of the value 
and soundness of other EU banks. This can unnecessarily raise the funding costs for the sector as 
a whole, which may adversely affect the cost of credit to borrowers.  

Addressing high stocks of NPLs and their possible future accumulation is therefore essential for 
restoring the competitiveness of the banking sector, preserving financial stability and supporting 
lending to create jobs and growth. This analysis is shared by a number of reports from European 
institutions, international organisations, and think tanks.11  

1.2.  Recent evolution of NPLs 

The general improvement in NPL ratios over recent years continued in 2017, as did the quality of 
banks’ loans portfolios. The latest figures confirm the downward trend of the NPL ratio, which 
declined to 4.6% (Q2 2017), down by roughly 1 percentage point (pp) year-on-year (see Figure 
1). This reduction was mainly the result of one‐off events that impacted all bank‐size classes, in 
particular smaller banks. However, the ratio remains elevated when compared to historical norms 
and to other regions12 and the total volume of NPLs across the EU is still at the level of EUR 950 
billion.13  

The  situation  differs  significantly  across  Member  States  (see  Figure  2).  Several  countries  still 
have high NPL ratios (9 had ratios above 10% in the second quarter of 2017), while others have 
rather low ratios (10 Member States were below 3%). 

There is evidence of some progress in reducing NPL ratios in the most affected countries, owing 
to  a  combination  of  policy  actions  and  a  stronger  macroeconomic  environment.  However, 
significant  risks  to  economic  growth  and  financial  stability  remain  and  progress  is  still  slow, 
especially where it is needed the most. Structural impediments continue to hamper a faster fall in 
NPL stocks. Provisioning is often still too slow and insufficient to allow for effectively resolving 
and preventing any critical accumulation of NPLs in the future. Among other elements, activity 
on  secondary  markets  for  NPLs  is  also  not  yet  sufficient  to  substantially  contribute  to  NPL 
reduction  efforts,  notwithstanding  the  increased  interest  from  certain  investor  groups  and  the 
increasing volume of NPL-related transactions. 

Figure 1: EU NPL ratio 

Figure 2: NPL ratio in EU Member States 

Source: ECB. Note: Dec-2014 not available for CZ. 

11 See ECB (2016, 2017), EBA (2017), FSC (2017), ESRB (2017), IMF (2015a, b), Vienna Initiative (2012), Baudino 
and Yun (2017), Bruegel (2017), Barba Navaretti et al. (2017). 
12 The NPL ratio for both the United States and Japan was around 1.5 % in December 2016. 
13 Source: ECB. 

6 

3.54.55.56.52014-Q42015-Q22015-Q42016-Q22016-Q42017-Q2European UnionSource: European Central BankGross non-performing loans and advances(in % of total gross loans and advances, end-of-period values)01020304050ATBEBGCYCZDEDKEEESFIFRUKELHRHUIEITLTLULVMTNLPLPTROSESISK%Dec-14Jun-17 
 
 
                                                            
1.3.  Towards a comprehensive package of measures to address NPLs 

A comprehensive and credible strategy to address NPLs is an  essential and urgent step towards 
restoring the viability of – and hence investor confidence in – the EU banking sector. Pursuing a 
comprehensive  strategy  and  taking  determined  action  to  address  NPLs  is  also  essential  for  the 
smooth functioning of the Banking Union and the Capital Markets Union (CMU) and for a stable 
and integrated financial system. In this way, the resilience of the Economic and Monetary Union 
to adverse shocks will be enhanced by facilitating private risk-sharing across borders, while at the 
same time reducing the need for public risk-sharing.  

Integrating  national  and  EU-level  efforts  is  needed  to  address  the  NPL  problem,  both  on  the 
existing  NPL  stocks  and  on  future  NPL  flows.  Reflecting  the  EU  dimension  and  building  on 
previous  work  by  the  Commission  and  other  competent  EU  authorities,  the Council  adopted  in 
July 2017 an Action Plan To Tackle Non-Performing Loans in Europe.14 It recognises that work 
in  this  area  must  be  based  on  a  comprehensive  approach  combining  a  mix  of  complementary 
policy actions, since the complexity of the problem simply does not lend itself to a single ‘silver 
bullet’ solution.  

The Council Action Plan combines various measures by national governments, bank supervisors 
and  EU  institutions/agencies  that  improve  the  tools  and  incentives  for  banks  to  pro-actively 
address NPLs either by internal work-out or through disposal. In practice, this means enhancing 
legal  frameworks  relevant  for  both  the  prevention  and  resolution  of  NPLs,  including  the 
functioning  of  secondary  markets.  However,  other  measures  such  as  improving  the  availability 
and  quality  of  data  on  NPLs  or  improving  the  market  infrastructure  (e.g.  set-up  of  trading  or 
information platforms) are equally important. If the right pre-conditions are present, tools such as 
Asset  Management  Companies  are  also  an  efficient  way  to  allow  resolution  of  NPLs  while 
removing NPLs from the banking system in the short term.  

The  Commission  has  committed  to  delivering  on  the  parts  of  the  NPL  Action  Plan  within  its 
remit.  Accordingly,  the  Commission  announced  in  its  October  2017  Communication  on 
completing  Banking  Union  a  comprehensive  package  for  tackling  high  NPL  ratios,  to  be  put 
forward by Spring 2018.15  

This "Spring package" consists of the following measures:  

  A  Blueprint  for  how  national  Asset  Management  Companies  (AMCs)  can  be  set  up  in 
compliance  with  existing  EU  banking  and  State  aid  rules  by  building  on  best  practices 
learned from past experiences in Member States.  

  A  legislative  initiative  to  further  develop  secondary  markets  for  NPLs,  especially  with 
the  aim  of  removing  undue  impediments  to  loan  servicing  by  third  parties  and  to  the 
transfer of loans to third parties.  

  A  legislative  initiative  to  enhance  the  protection  of  secured  creditors  by  allowing  them 
more  efficient  methods  of  value  recovery  from  secured  loans  through  Accelerated 
Extrajudicial  Collateral  Enforcement  (AECE).  This  refers  to  an  expedited  and  efficient 
out-of-court  enforcement  mechanism  which  enables  secured  creditors  (banks)  in  all 
Member States to recover value from collateral granted by companies and entrepreneurs 
to secure loans.16  

14 See http://www.consilium.europa.eu/en/press/press-releases/2017/07/11/conclusions-non-performing-loans/ 
15  COM(2017)  592  final,  11.10.2017,  available  at:  http://ec.europa.eu/finance/docs/law/171011-communication-
banking-union_en.pdf. 
16 This initiative will remain consistent with and complementary to the Commission proposal of November 2016 for a 
Directive on, inter alia, preventive restructuring frameworks and would not require harmonisation of actual insolvency 
provisions. 

7 

 
                                                            
  A legislative initiative amending the Capital Requirement Regulation (CRR), with regard 
to the introduction of minimum coverage requirements for incurred and expected losses 
on future NPLs arising from newly originated loans, in order to backstop potential under-
provisioning of future NPLs and prevent their build-up on banks’ balance sheets.  

  A  way  forward  to  foster  the  transparency  on  NPLs  in  Europe  by  improving  the  data 
availability  and  comparability  as  regards  NPLs,  and  potentially  supporting  the 
development by market participants of NPL information platforms or credit registers. 17 

The Council Action plan initiatives under the responsibility of other EU institutions, agencies and 
competent authorities include, among others:  

  General guidelines on NPL management applicable to all EU banks;  

  Detailed  guidelines  on  banks'  loan  origination,  monitoring  and  internal  governance, 

addressing in particular transparency and borrower affordability assessment;  

  Macro-prudential  approaches  to  prevent  the  emergence  of  system-wide  NPL  problems, 
taking  into  account  potential  pro-cyclicality  and  financial  stability  implications  of  NPL 
policy measures; 

  Enhanced disclosure requirements on banks' asset quality and non-performing loans. 

1.4.  Commonalities and interdependencies of the various measures 

The  legislative  and  non-legislative  initiatives  of  the  Council  Action  plan  are  interlinked  and 
mutually reinforcing. They should create the appropriate environment for dealing with NPLs on 
banks'  balance  sheets.  Some  of  them  have  an  impact  on  the  reduction  of  the  current  stock  of 
NPLs,  and  all  are  relevant  for  reducing  risks  of  future  NPL  accumulation.  Their  impact  is 
expected  to  be  different  across  Member  States  and  affected  institutions.  Some  will  have  a 
stronger  impact  on  banks'  ex  ante  risk  assessment  at  loan  origination,  some  will  foster  swift 
recognition  and better management  of NPLs,  and others will enhance the  market  value of such 
NPLs.  

The Commission's three legislative initiatives, namely i) statutory prudential backstops for loan 
loss  coverage;  ii)  the  development  of  secondary  markets  for  NPLs,  and  iii)  accelerated 
extrajudicial collateral enforcement mechanisms, mutually reinforce each other and also interact 
with  the  other  measures  of  the  Council  Action  Plan.  For  example,  the  prudential  backstops 
initiative  ensures  that  credit  losses  on  future  NPLs  are  sufficiently  covered,  making  their 
resolution  and/or  disposal  easier.  These  effects  would  be  complemented  by  better  developed 
secondary markets for NPLs as these would make demand for NPLs more competitive and raise 
their  market  value.  Furthermore,  accelerated  collateral  enforcement  as  a  swift  mechanism  for 
recovery  of  collateral  value  would  reduce  the  costs  for  resolving  NPLs.  These  interactions  are 
described in greater detail in the below box. 

17 In addition, the Commission is also undertaking a benchmarking exercise of loan enforcement regimes to establish a 
reliable  picture  of  the  delays  and  value-recovery  banks  experience  when  faced  with  borrowers'  defaults,  and  invites 
close cooperation from Member States and supervisors to develop a sound and significant benchmarking methodology. 
In this context, the 2016 Commission proposal for a Directive on business insolvency, restructuring and second chance 
lays down obligations on Member States to collect comparable data on insolvency and restructuring proceedings. 

8 

 
                                                            
Figure 3 Commission's policy initiatives within the NPL Action Plan 

Box on the reinforcement effects between the Commission's legislative initiatives 

This  box  assesses  the  possible  reinforcement  effects  between  the  three  initiatives  of  the  Spring 
package,  namely  i)  statutory  prudential  backstops  for  loan  loss  coverage;  ii)  development  of 
secondary  markets  for  NPLs,  and 
iii)  accelerated  extrajudicial  collateral  enforcement 
mechanisms. As is the usual practice, each individual impact assessment gauges the incremental 
effects of the proposed measure against a no policy change baseline. The underlying idea of the 
NPL  package  is,  however,  that  the  effects  of  each  initiative  will  be  mutually  enhancing.  The 
exact quantification of these feedback effects is a quite complex exercise as it is subject to strong 
modelling uncertainty. This box hence provides a qualitative description of the feedback channels 
and their relative strength.  

9 

                                            Statutory prudential backstops  Banks' immediate recognition of NPLs Market access to NPL investors and loan servicers Higher recovery value of NPLs Bank supervision Better risk assessment in lending decisions Reform of debt restructuring and recovery, insolvency frameworks Enabling secondary markets for NPLs Data standardization and transaction platforms Asset management companies Powers of bank supervisors Collateral enforcement Insolvency reform and loan enforcement             
 
Figure 4: The reinforcement effects between the initiatives of the NPL package 

Effects of Accelerated extrajudicial collateral enforcement (AECE) on other initiatives 

As  AECE  becomes  more  popular  and  used  by  credit  institutions,  the  statutory  prudential 
backstop  measures  would  be  less  binding.  Indeed,  banks  would  tend  to  restructure,  recover  or 
dispose  of  their  NPLs  earlier  and  at  a  higher  rate.  They  would  be  less  affected  by  the  need  to 
increase provisioning as time goes by, as required by the prudential backstops measures. 

Given that the AECE feature would follow the NPLs following their disposal to a third party, this 
would  help  the  development  of  the  secondary  market  by  increasing  investor  participation  and 
thereby  its  liquidity  (NPL  demand-side  effects).  In  particular,  shorter  time  of  resolution  and 
increased  recovery,  as  expected  with  AECE,  would  increase  the  bid  prices.  Moreover,  the 
harmonization  achieved  by  AECE  would  foster  development  of  pan-European  NPL  investors, 
further improving market liquidity. 

Effects of Statutory prudential backstops on other initiatives 

The more costly in terms of higher provisioning it becomes for banks to keep secured corporate 
NPLs on their balance sheets due to the new prudential backstop rules, the higher the incentives 
for banks to restructure, recover or dispose of NPLs quicker and earlier, and hence the higher the 
use of AECE directly (by triggering it) or indirectly (by disposing of the NPL to a third party). 

Holding  NPLs  on  the  balance  sheet  will  become  costly  over  time,  providing  an  incentive  for 
banks to dispose of NPLs on the secondary markets at an early stage, when the backstops require 
less  minimum coverage. Once the minimum coverage level required by the backstops becomes 
more binding, the carrying book value of NPLs will be reduced. Both of these mechanisms would 
ensure  more  sellers  participation  on  the  secondary  market  (NPL  supply-side  effect),  thereby 
reducing the ask price of NPLs. 

Effects of the development of secondary markets for NPLs on other initiatives 

10 

 
 
 
Improved  investor  participation  and  better  functioning  of  secondary  markets  would  reduce  the 
bid-ask spread and increase the volume of NPLs that are transferred to third parties. Banks would 
dispose of NPLs more eagerly and at an earlier stage, therefore the provisioning backstop would 
be less often binding. 

With  a  more  liquid  and  better  functioning  secondary  market  for  NPLs  where  investors  show 
appetite  for  NPLs  with  the  AECE  feature,  there  would  be  additional  incentives  for  credit 
institutions to use AECE at origination of new loans. This indirect feedback effect would become 
active once sellers realise that it is easier to dispose of NPLs having the AECE feature to third 
party investors.  

The  effectiveness  of  the  three  aforementioned  legislative  measures  would  increase  if  banks  are 
adequately capitalised in the future. Better capitalised banks will be more eager to sell NPLs in 
the  secondary  market  or  to  realise  the  collateral  of  a  non-performing  loan  in  a  timely  fashion. 
Furthermore,  statutory  minimum  coverage  requirements  would  provide  strong  incentives  for 
banks' management to prevent the accumulation of future NPLs through better NPL management 
and stronger loan origination practices. This will reinforce the expected effects of the EBA’s and 
ECB’s work on banks' loan origination, NPL management, monitoring and internal governance 
practices.  Work  on  NPL  information  and  market  infrastructure  would  further  enhance  the 
functioning  of  NPLs  secondary  markets.  Lastly,  measures  related  to  loan  enforcement  would 
complement the Commission's November 2016 proposal for a Directive on business insolvency, 
preventive  restructuring  and  second  chance,  by  increasing  the  chances  that  viable  businesses 
survive while non-viable activities are swiftly resolved.18 

18 COM(2016) 723 final. 

11 

 
 
 
                                                            
BACKGROUND INFORMATION ON LOAN LOSS PROVISIONING 

Recent developments in banking systems around the world illustrate the continued importance of 
proper provisioning. Two such examples are the Asset Quality Review (AQR) exercise in the EU 
and initiatives of unifying the definitions of NPEs and exposures subject to forbearance measures 
at  the  European  and  international  level.19  Credit  quality  inadequacies  and  their  resulting  losses 
have always been one of the primary causes of bank failures. Almost ten years after the onset of 
the  global  financial  crisis,  despite  ongoing  regulatory  reforms  and  rounds  of  organized  stress 
testing, deleveraging, and balance sheet repair exercises, loan loss provisioning and asset quality 
remain  key  issues  for  banks.  Provisioning  merits  particular  attention  given  its  vital  role  in 
ensuring  the  safety  and  soundness  of  the  banking  system.  According  to  IMF  staff  “[u]nder-
provisioning  is  generally  the  single  greatest  distortion  in  the  calculation  of  capital  and  capital 
adequacy”.20 

Provisioning is a risk management tool to address credit risk by setting aside a given amount (of 
cash/capital),  referred  to  as  loan  loss  provision  (LLP)21,  as  a  buffer  to  absorb  incurred  and 
expected  losses  on  a  financial  instrument  such  as  a  loan.  LLPs  allow  banks  to  recognize  the 
estimated loss in their income (“profit & loss”) statements and balance sheets22, even before the 
actual loss can be determined with full accuracy and certainty as events unfold. When loan losses 
eventually materialise, banks can draw on LLPs, thereby absorbing the losses without reducing 
capital and preserving banks' capacity to continue lending to the economy.23 

Losses  on  credit  exposures  including  NPLs  are  subject  to  both  accounting  standards  and 
prudential  regulation.  However,  neither  the  international  accounting  nor  the  prudential 
framework  does  currently  provide  for  a  common  minimum  treatment  with  regards  to 
incurred/expected losses on NPLs. 

Accounting treatment: from IAS 39 to IFRS 9 

Following the global financial crisis, the G20 leaders, investors and regulators called for actions 
to  improve  LLP  standards  and  practices,  by  replacing  the  International  Accounting  Standard 
(IAS)  39  standard  with  a  new,  forward-looking  principle.  In  particular,  the  International 
Accounting Standards Board (IASB) received the mandate to set a new standard to allow banks 
to "fully recognise existing credit losses earlier in the credit cycle" and, as such, to address the 
flaws  of  a  "too  little,  too  late"  provisioning.  In  response  to  the  G20's  mandate,  the  IASB 
formulated a new accounting standard for the classification and measurement of financial assets 
and liabilities, the so called International Financial Reporting Standards (IFRS) 9, which will be 
applied in the EU starting with January 201824. 

The most important change of IFRS 9 compared to IAS 39 is the change from an "incurred credit 
loss"  approach  to  an  "expected  credit  loss"  (ECL)  approach  for  determining  credit  losses  of 

19 Both the EBA and the BCBS have adopted harmonized and consistent definitions of both NPE and forbearance (i.e., 
restructuring or refinancing of troubled debt), thereby fostering consistency in supervisory reporting. 
20 Cf. IMF (2014) op. cit. 
21  The  terms  ‘impairments’,  ‘provisions’  and  ‘value  adjustments’  effectively  have  the  same  meaning.  To  be  more 
accurate,  ‘impairments’ refer to the  losses for  on  balance  sheet exposures under  IFRS  more  commonly,  ‘provisions’ 
refer to the losses for off-balance sheet exposures under Directive 86/635/EEC (Bank Accounting Directive) and ‘value 
adjustments’ to the impairment for loans and advances on balance sheet under the same Directive. 
22 On the balance sheet, LLPs are recognised as negative assets and (due to balance sheet identity) as a corresponding 
decline of the bank's equity. 
23  Ideally,  provisions  should  anticipate  deteriorating  economic  conditions  that  may  affect  borrowers'  ability  to  repay 
their obligations. In such a way, they can be used to cover expected losses, while bank capital serves as a buffer against 
unexpected losses (see Laeven and Majinoni (2003)). 
24 The Commission adopted on 22 November 2016 a Commission Regulation (OJ L 323, 29.11.2016, p. 1, available at 
http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32016R2067&from=EN)  requiring  the  use  of  IFRS 
9 "Financial instruments" for financial years starting on or after 1 January 2018. 

12 

 
                                                            
financial instruments other than those measured at fair value through profit or loss. Specifically, 
the  IFRS  9  requires  banks  to  recognise  ECLs  before  having  objective  evidence  of  impairment, 
that is, even if no past "triggering" events (e.g., loss of employment of the borrower, decrease in 
collateral values, or past-due status) have occurred. Banks will then update the ECLs recognised 
at each reporting date to reflect changes in credit risk as estimated using a large set of historical, 
current,  and  forecast  information,  including  forward-looking  macroeconomic  variables.  The 
inclusion  of  these  variables  into  the  assessment  procedure  is  expected  to  favour  earlier  and 
possibly higher provisions. 

The IFRS 9 ECL approach is based on three stages. 

"Stage 1" refers to performing financial instruments for which the credit risk has not significantly 
increased since initial recognition. For stage 1 the reporting entity has to determine the expected 
credit  losses  from  default  events  over  the  next  twelve  months.  The  amount  of  expected  credit 
losses is the discounted difference between contractual cash flows and the cash flows the entity 
actually expects including contractual options and cash flows from the sale of collateral. 

"Stage 2" refers to non-impaired (performing) financial assets whose credit risk has significantly 
increased since initial recognition. There is a rebuttable assumption that this is the case when the 
loan  becomes  more  than  30  days  past  due.  For  stage  2  the  reporting  entity  has  to  estimate  the 
probably  of  default  over  the  remaining  maturity  of  the  financial  instrument  and  calculate  the 
corresponding expected credit loss. 

"Stage 3" refers to financial assets that are credit impaired, i.e. for which an objective impairment 
event has occurred and hence the probability of default is "1". Stage 3 is referred to as life time 
expected losses and is broadly speaking the same as what is done under the impairment approach 
of current IAS 39. 

Finally,  IFRS  9  requires  the  reporting  entity  to  write-off  a  loan  when  there  is  no  reasonable 
expectation  to  recover  the  loan.  A  write-off  is  a  "de-recognition"  event  which  implies  that  the 
loan will no longer be on the balance sheet of the bank and hence not count towards its stock of 
NPLs. 

To summarise, compared  to IAS 39 the new IFRS  9  expected  credit  loss approach will lead  to 
earlier and fuller recognition of credit losses when loans are still performing (Stage 1 and 2). The 
new rules require banks to build provisions in a timely way only at impairment of the loan. This 
has the effect of mitigating the risk of cliff effects when many loans become non-performing at 
the  same  time  (for  example  during  an  economic  downturn).  Regarding  loans  which  are  non-
performing (Stage 3), the new standard will largely keep the same treatment as IAS 39 and, by 
itself, cannot be expected  to ensure that banks will  ultimately create  sufficient LLPs for NPEs. 
Also, IFRS 9 sets more general principles and approaches for determining credit loss provisions 
as opposed to detailed rules. Despite the available guidance on its application, there is discretion 
within the new standard which in practice might lead to lower levels of LLPs, in particular when 
valuing collateral or third party guarantees for secured loans. 

At  the  same  time  not  all  banks  apply  IFRS:  in  several  EU  MSs  and  in  many  third  countries 
national  Generally  Accepted  Accounting  Principles  (GAAPs)  apply  which  might  follow  a 
different provisioning approach than IFRS.  

Furthermore, some jurisdictions have adopted specific provisioning rules for banks' NPLs, while 
a  few  others  have  adopted  provisioning  guidelines  specifying  the  implementation  of  IFRS  (see 
section 3 and Annex 4). 

Prudential treatment: Pillar 1 and Pillar 2 

13 

 
Current  prudential  regulation  under  so-called  “Pillar  1”  deals  differently  with  provisions 
depending  on  whether  banks  determine  their  regulatory  minimal  capital  requirements  using  the 
Standardised Approach (SA) or the Internal Ratings-Based (IRB) approach. Only under the IRB 
approach  current  regulatory  provisions  are  already  determined  following  an  ECL  approach, 
although with differences to IFRS 9.25 For IRB banks, when there is a “provisioning shortfall”, 
i.e.,  when  regulatory  expected  losses  (EL)  exceed  accounting  provisions,  said  shortfall  is 
deducted  from  Common  Equity  Tier  1  (CET1)  capital.  As  regards  credit  exposures  that  are  in 
default (such as NPLs), banks must use their best estimate of expected losses (ELBE) based on the 
principle  that  banks  would  have  to  recognize  additional  unexpected  losses  during  the  recovery 
period. It is currently widespread practice to use accounting provisions as ELBE estimates and the 
treatment of NPLs has been found very heterogeneous among banks.26  

There is no common minimum treatment with regards to incurred and expected losses on NPLs, 
neither  at  EU  nor  at  global  level.  In  this  respect,  several  countries  have  introduced  mandatory 
(prudential)  provisioning/writing-off  regimes  (or  have  intensified  existing  regimes),  post-crisis. 
For instance, banks in the United States, Japan or Brazil are required to fully provision and write 
off NPLs after a set period (see section 3. and Annex 4). 

Under so-called “Pillar 2” competent authorities (CAs) in charge of supervising institutions in the 
EU have the power to influence their provisioning policy and to require specific adjustments to 
the own funds calculations on a case-by-case basis.27 Accounting powers do however not fall into 
the remit of CAs which is why it is not possible for a CA to impose a specific provision to be 
registered in a bank's financial accounts – supervisory powers rather act as a “prudential overlay” 
which affects solely a bank’s prudential figures, i.e. by decreasing its regulatory own funds with 
the  adjustments  being  reflected  in  supervisory  reporting  and  own  funds  disclosure.  Pillar  2 
measures can only be applied on discretion of the CA and on a case-by-case basis, following an 
assessment  that the provisioning policy chosen by the institution is not adequate or sufficiently 
prudent  from  a  supervisory  point  of  view.  Under  the  current  rules,  no  harmonised  (minimum) 
treatment can be imposed by CAs. 

25 The horizon over which ECLs are estimated is always one year and the inputs of the estimation are through-the-cycle 
(rather than point-in-time) probabilities of default and stressed (rather than unbiased) loss given default. 
26 Cf. EBA (2017a, b); the EBA also found that the proportion of defaulted exposures is one of the main drivers of the 
variability of risk-weights within each bank’s portfolio. 
27 To eliminate any doubts about the scope of this power, the Commission clarified in the SSM review report, that the 
existing EU legislation, in particular Article 16(2)(d) SSM Regulation (SSMR) and Article 104(1)(d) CRDIV, allows 
supervisors  to  require  more  provisioning  within  the  limits  of  the  applicable  accounting  standards  on  a  case-by-case 
basis. In case the accounting framework leaves room for institutions’ discretion, and banking supervisors consider the 
way  an  institution  used  this  discretion  as  not  adequate  or  insufficiently  prudent,  they  are  entitled  to  impose  higher 
provisioning, deductions or filters. 

14 

 
 
 
                                                            
2.  PROBLEM DEFINITION 

2.1.  What is/are the problems? 

2.1.1.  Build-up of under-provisioned NPLs  

  ud                g      N L                         u    b  k ’               u d        d  b  
consequence their ability to lend to the economy. Provisioning is a key risk management tool 
to address incurred and expected losses on credit exposures without reducing capital when those 
losses  materialise  thereby  preserving  banks'  capacity  to  continue  lending  to  the  economy  (see 
above  Background  Information).  A  prudent  provisioning  policy  is  thus  key  determinant  for 
banks’  financial  soundness,  in  particular  in  a  recession  when  many  loans  become  non-
performing.28  

Prudent provisioning of NPLs has proved to be crucial to effectively resolving bad loans in 
the  European  and  international  experience.29  Restructuring,  selling  or  dismissing  non-
performing  assets  and  non-recoverable  collateral  requires  less,  if  any,  additional  capital,  if 
sufficiently  high  provisions  for  credit  losses  on  NPLs  have  been  made,  and  therefore  becomes 
potentially  easier.  Recent  analysis  confirms  that  increases  in  coverage  ratios  at  bank  level  are 
usually followed by a higher reduction in NPLs in the following quarters (as illustrated in Figure 
5).30  Insufficiently  provisioned  NPLs,  on  the  contrary,  are  more  likely  to  remain  on  banks’ 
balance  sheets  in  an  attempt  by  banks  to  avoid  or  delay  loss  recognition  (“wait-and-see” 
approach,  see  below  2.2.).  Delays  in  loss  recognition  may  cast  doubt  over  banks’  future 
profitability, solvency and long-term viability, as delays force banks to increase provisions during 
economic downturns, when cumulative losses materialise and capital requirements become most 
binding.31 In addition, heightened risk perceptions on the part of investors and depositors usually 
translate into higher funding costs.32 In sum, under-provisioning and loss forbearance as regards 
NPLs may ultimately result in higher lending rates, reduced lending volumes, and increased risk 
aversion (see consequences in 2.2.). 

Figure  5:  Quadrant  model 
potential 
a 
showing 
relationship  between  NPL 
and coverage ratio trends 

Source:  EBA, 
Risk 
Assessment  Report  of  the 
European  Banking  System 
(December 2016) 

Notes: 
Starting  off  with 
a  high  stock  of  impaired 
assets  and  a  low  coverage 
ratio  (quadrant  1),  banks 
may increase their coverage 
ratio 
the 
worsening  condition  of  the 
NPL.  As  the  gap  between 
transaction  prices  offered 
by  potential  buyers  (“bid”) 
and net book values (“ask” being the result of the gross carrying amount minus LLPs) at which NPLs are recognised in 
banks’  balance  reduces,  banks  are  better  able  to  dispose  of  NPLs  (quadrant  2).  After  having  decreased  the  level  of 

reflect 

to 

28  Once  the  loan  is repaid  in  full  and  does  not  default,  the  LLP is  dissolved  and  the  bank  reports  a  correspondingly 
higher income. 
29 See cet. par. FSI (2017a) or IMF (2015c). 
30 For example, this was noticed in banks in Croatia, Romania and Slovenia; a similar pattern may unfold for Cyprus in 
the following quarters (EBA [2017c]). 
31 This suggests that delays in expected loss recognition increase the pro-cyclicality of bank lending (BCBS [2015]). 
32 Cf. ESRB (2017), op. cit. and IMF (2015a), op. cit. 

15 

 
                                                            
impaired  loans,  thereby  freed-up  capital  and  human  resources  can  be  used  to  further  reduce  the  stock  of  NPLs,  in 
particular “aged” ones with high coverage ratios (moving from quadrant 3 to quadrant 4). 

2.1.2. 

“   k          k ”    EU b  k  g          d                -over effects 

The  gross  carrying  amount33  of  NPLs  in  the  EU  banking  system  at  the  end  of  2016 
amounted  to  just  below  EUR  1  trillion,  with  remarkable  discrepancies  across  banks  and 
MSs. The NPL ratio is highly dispersed across EU countries ranging from 1 % to 46%. NPLs are 
concentrated in a few MSs: almost 90% of the overall amount of NPLs in the EU is located in 10 
MSs (see Figure 6). At the same time, in over one-third of EU countries the ratio exceeds 10% (in 
order  of  descending  NPL  ratio:  Greece,  Cyprus,  Portugal,  Italy,  Slovenia,  Ireland,  Bulgaria, 
Hungary, Romania and Croatia). 

Figure 6: Gross and net NPLs (EUR bn) 

Source:  ESRB Secretariat calculations based on ECB Consolidated Banking Data 
Notes:  Reference  date  for  gross  and  net  NPLs  columns  is  Q4  2016.  Data  includes  domestic  banks,  stand-alone 

banks, except Slovenia (Q1 2016) and foreign controlled subsidiaries and branches. 

NPL coverage ratios34 (CovR) in the EU also differ across banks and MSs both in terms of 
level and evolution and according to the size of banks.35 Differences depend on a number of 

33  The  gross  carrying  amount  of  NPLs  corresponds  to  the  total  amount  owed  by  the  borrower  which  has  not  been 
written off. The book value of NPLs, or the net carrying amount, is calculated by adjusting the gross carrying amount 
by: i) accumulated impairments, for loans measured at amortised costs; or ii) accumulated changes in fair .value due to 
credit risk, for loans measured at fair value. The net NPL amount excludes losses already recognised by the bank (e.g. 
through LLPs) and, therefore, represents the potential additional loss for the bank. At the same time, it is important to 
note that impairment (or provisioning) is not always estimated in accordance with the same accounting standards. 
34 LLPs for loans and advances to customers as a percentage of NPLs and advances to customers. 

16 

 
 
                                                            
factors  which  are  difficult  to  disentangle  (see  also  below  2.2.3.).  One  of  these  factors  is  the 
collateralization  of  NPLs  which  may  play  a  relevant  role  in  explaining  provisioning  policies 
across  banks.  In  principle  NPLs  secured  by  collateral  are  perceived  to  be  less  risky.  For  this 
reason,  banks  normally  provision  less  compared  to  provisioning  non-collateralized  loans.  The 
quality and the amount of collateral affect loan recovery rates and, therefore, the "expected loss" 
on a NPL. Consequently, collateralized loans have on average lower NPL coverage ratios. Within 
the EA, 36% of the gross carrying amount of NPLs are covered by collateral (“secured NPLs”) 
while 46% are covered by provisions (see Figure 7). 

Figure 7: Provisioning and collateral (% of NPLs) 

Source:  Constancio, Resolving Europe's NPL burden (2017) based on ECB Supervisory Statistics 
Note: 

Countries ordered by NPL ratio; I6 refers to high-NPL MSs: CY, GR, IE, IT, PT and SI; I13 are other EA 
MSs) 

Taking at face value, these figures would suggest that 20% of NPLs stock in the EA represents a 
true  risk  on  banks’  balance  sheets,  being  the  residual  covered  through  either  collateral  or 
provisions.36 However, effective loss coverage provided by existing collateral depends, inter alia, 
on the characteristics of the underlying asset market as well as on the actual accessibility to that 
collateral.37 For example, collateral provides for effective protection against losses on NPLs only 
as  long  as  its  present  value  is  not  eroded  by  lengthy  and  costly  enforcement  procedures  (see 
Figure 8).38 

35 Dispersion of the provision coverage ratio across MSs and banks is significant, with the EU average slightly at 45% 
and values in the range of 26% to 68% (cf. EBA, Risk Assessment Report of the European Banking System [November 
2017]). 
36 Carletti and Brunella (2017), "Provisioning policies for non-performing loans: How to best ensure a clean balance 
sheet?" European Parliament Economic Governance Support Unit. 
37 Ibidem. 
38  Cf.  Constancio  (2017)  "Resolving  Europe's  NPL  burden".  For  example,  the  average  length  of  foreclosure 
proceedings in Italy is almost five years compared to less than one year in Germany and Spain. 

17 

 
 
 
 
 
                                                                                                                                                                                 
Figure 8: Average time to foreclosure (years) and NPL ratios (%) 

Source: 

IMF, Country Report 15/205 

The uncertainty about the valuation of NPLs, in particular secured ones, translates into a 
wide  gap  in  price  expectations  of  investors  and  banks  (i.e.  differences  between  transaction 
prices  offered  by  potential  buyers  [“bid”]  and  net  book  values  [“ask”]  at  which  NPLs  are 
recognised in banks’ balance – so-called “bid-ask spread” or “pricing gap”). The data on the size 
of that gap is scant but it is thought to be very large. For instance, estimates  suggest that, for a 
fully collateralised NPL, the discount required by a private investor may exceed 40% mainly due 
to the cost, time and uncertainty of the recoveries.39 It follows that provisioning levels might not 
yet truly reflect the actual risk of losses on NPLs. 

The pace of reduction in NPLs in the EU has been slow. As shown in Figure 5 NPL ratios are 
now higher than in 2009, and in most cases, they have not returned to pre-crisis levels. A large 
majority of EU MSs reports NPL ratios to be above  those of the United States or Japan.40 The 
ESRB  noted  that  in  spite  of  the  recent  improvement  in  macroeconomic  conditions  and  the 
subsequent  decrease  in  flows  of  new  NPLs  have  helped  some  countries  to  start  to  reduce  their 
NPL stock from the peak levels seen in 2012/13, EU banks have generally not shown satisfactory 
progress in resolving their stocks of NPLs, which have been piling up on their balance sheets for 
a number of years.41 

39 Ibidem. 
40 For both the United States and Japan, the NPL ratio was around 1.5 % in December 2016, according to IMF and 
World Bank data (see e.g. http://data. worldbank.org/indicator/FB.AST.NPER.ZS?locations=US). 
41 Cf. ESRB (2017) op. cit. and IMF (2015a) op. cit.  

18 

 
 
 
                                                            
Figure 9: NPL ratio and changes since 2009 (% of gross loans) 

IMF Financial Soundness Indicators and ESRB Secretariat calculations 

Source: 
Notes:  Data refers to Q4-2016, except for Cyprus, Portugal, Ireland, Belgium, Denmark, Germany, United Kingdom 
and  Lithuania  (all  Q4-2015),  and  Luxembourg  (Q4-2014).  Data  for  Denmark  starts  in  2010.  No  data  is 
available for Finland. Countries are ordered according to the change in the NPL rate since 2009 

Although  average  provisioning  levels  have  recently  increased  in  certain  MSs  facing  high 
NPL  stocks,  loss  recognition  is  often  still  too  slow  and  insufficient  to  allow  for  effectively 
resolving NPLs and preventing the accumulation of future NPL-stocks. Additional efforts are 
necessary;  especially  in  some  MSs  and  for  some  banks,  provisioning  levels  may  need  to  be 
increased  further,  reducing,  inter  alia,  the  large  bid-ask  spreads42  (see  Figure  10)  and  allowing 
banks to dispose of NPLs more easily at an earlier stage and to higher levels of recovery.  

Figure 10: Difference between the net book value and the estimated bid price of a sample of collateralised NPLs 

Sources:  ECB calculations based on the World Bank’s Doing Business 2017 and ECB data.  
Notes:  The  market  price  for  secured  NPEs  reflects  the  expected  time  to  recover  the  residual  value  of  distressed 
assets  (being  lower  where  foreclosure  times  are  longer  and  debt  enforcement  regimes  weaker)  and  the 
expected  return  on  investment  consistent  with  general  profit  expectations  in  distressed  debt  markets.  The 
blue  segments  of  the  bars  represent  the  reported  average  cost  of  enforcing  claims  through  individual  legal 
systems,  whereas  the  yellow  segments  represent  the  additional  discount  that  results  from  using  an  internal 
rate of return (IRR) of 15%, assumed to represent the premium required by investors for the risk of acquiring 
NPLs.  The  cost  of  debt  recovery  includes  court  fees  and  government  levies;  fees  of  insolvency 
administrators,  auctioneers,  assessors  and  lawyers;  and  all  other  fees  and  costs.  It  does  not  include 

42  The  Commission’s  initiative  on  Secondary  Markets  for  NPLs  identifies  the  associated  problems  and  proposes 
solutions  which  would  be  complemented  and  reinforced  by  the  initiative  statutory  prudential  backstops  (see  section 
6.5.). 

19 

 
 
 
                                                            
operational expenses incurred by the creditor, such as wages and salaries of involved staff members, or the 
cost of IT infrastructure used to manage NPLs. Inclusion of these costs would reduce net present values even 
further. 

The accumulation of NPLs without sufficient loan loss coverage in parts of the EU banking 
               “   k          k”. The EU banking system is fairly integrated, even more in the 
EA:  the  percentage  of  banking  institutions  controlled  by  a  parent  institution  outside  a  MS 
continuously  increased  and  recently  reached  22%.  Cross-border  banking  loans  also  grew 
consistently  and  reached  8.5%  of  total  loans  outstanding  in  the  EA.43  While  there  are  strong 
benefits  from  financial  integration  in  terms  of  risk  diversification,  disruptions  of  the  financial 
system in one MS may also affect the financial system in other MSs. 

Spillovers  from  weaker  banks  and  weaker  countries  are  possible,  posing  a  threat  to 
financial stability and economic growth of the Union, particularly in the BU.44 The spillover 
effects  may  arise  both  within  the  banking  sector  and  between  the  banking  and  non-banking 
sectors.45  Banking  spillovers  relate  to  banks'  cross-border  lending  activities  and  cross-border 
ownership  links.46  Moreover,  financial  interconnections  and  interdependencies  between  banks 
across the BU and existing crisis management mechanisms lead to a more integrated perception 
of  the  EA  banking  sector  by  market  participants  (such  as  international  investors),  and 
occasionally, international institutions.47 

Because  national  economies  are  also  highly  interconnected  in  the  EA,  negative  effects  on  the 
growth perspectives in individual MSs can potentially spill-over to other Member States. These 
indirect channels relate to the overall deterioration of the macroeconomic environment in high-
NPL countries, which affects other countries through lower import demand (trade channel) and a 
loss of value of equity and debt claims on residents of the affected countries (financial channel).48 

2.2.  Consequences of insufficient loan loss coverage 

2.2.1.  N g       m         EU b  k ’             u d       d              b      

Excessively  discretional  (“too  little  and  too  late”)  recognition  of  losses  on  NPLs  has  several 
negative effects in terms of banks’ financial soundness and financial stability. 

If  NPLs  are  not  recognised  early  and  provisioned  adequately,  banks'  true  loss  absorbing 
capacity may be called into question, especially during a crisis. As discussed above (see section 
2.1.1.), delayed recognition of expected losses or incorrect estimates have an immediate effect on 
banks' earnings (current expenses are lower than they should be) and significant implications for 
their soundness.49 Outright losses can arise that weaken banks’ capital base, potentially bringing 
capital levels below or close to the minima required – giving rise to insolvency or illiquidity. At 
that  point,  banks  might  have  to  recapitalise  when  financing  conditions  are  cumbersome, 
especially when they and the wider system are in crisis. However, crises are the worst possible 
moment  for  a  bank  to  raise  capital,  as  investors  may  be  wary  of  subscribing  new  shares  when 
profits are falling and general economic conditions may be poor. Overall financial stability would 
be at risk if such problems were to arise in a substantial part of the banking system. 

43 See ECB consolidated banking data, available at 
https://www.ecb.europa.eu/stats/supervisory_prudential_statistics/consolidated_banking_data/html/index.en.html. 
44  EP  (2016);  IMF  (2015b).  In  the  same  vein  the  Council  concluded  that  “the  negative  effects  of  current  high  NPL 
ratios in a substantial number of MSs can pose risks of cross-border spill-overs in terms of the overall economy and 
financial system of the EU and alter market perceptions of the European banking sector as a whole, especially within 
the Banking Union” (Council conclusions on Action Plan to Tackle Non-performing Loans in Europe, 11 July 2017). 
45 Cf. ESRB (2017) op. cit. 
46 Ibidem. 
47 Cf. FSC (2017) "Report of the FSC Subgroup on Non-Performing Loans". 
48 Cf. ESRB (2017) op. cit. 
49 Carletti and Brunella (2017), op. cit.  

20 

 
                                                            
Moreover,  delaying  loss  recognition  damages  transparency  and  increases  investors' 
uncertainty  about  banks'  fundamentals,  which  may  impair  market  confidence  in  the  sector 
more  generally.  Heightened  risk  perceptions  on  the  part  of  investors  and  depositors  usually 
translate into increased risk aversion and higher funding costs (see section 2.2.2.) with potentially 
negative effects on the provision of credit to the real economy.50 

For all these reasons, an early and transparent recognition of NPLs and adequate provisioning are 
crucial to ensure banks have clear and sound balance sheets.51 

2.2.2. 

Impaired credit provision with negative impacts on real economy financing 
and growth 

As already mentioned in section 2.2.1., insufficiently provisioned NPLs may result in reduced 
bank lending to the real economy thereby potentially dragging on economic growth. 

There  are  two  main  channels  through  which  NPLs  could  slow  down  economic  recovery.  First, 
banks  with  under-provisioned  NPLs  might  be  impeded  to  extend  fresh  credit  (credit  supply 
channels) Second, borrowers face reduced incentives to invest. Assets remain under their control 
rather than being reallocated to more productive uses (non-credit supply channels). 

Credit supply channels 

Credit growth remains subdued in most of the MSs with currently high levels of NPLs (so-
called  Category  3  MSs)52  (see  Figure  11).  While  subdued  credit  dynamics  reflect  low  credit 
demand in a generally soft economy, the weakening of credit supply by high levels of NPLs play 
a  significant  role 
too.  Weak  credit 
demand  and  weak  credit  supply  are 
closely  intertwined:  a  credit  crunch  is 
bound 
to  weaken  macroeconomic 
performance and this will in turn weaken 
credit  demand.  Banks’  reduced  lending 
capacity 
to  disproportionately 
affect  firms  that  are  most  dependent  on 
bank finance53 such as SMEs.54 

tends 

Figure 11: 
non-financial 

MFI lending to 

corporations, EU 

(2010Q1-2016Q1) 
Source:  ECB, DG ECFIN calculations 

Several mechanisms are identifiable through which under-provisioned NPLs affect credit supply. 

Funding  costs  increase  when  NPL  levels  rise,  because  high  NPL  levels  raise  doubts  about 
the  true  capitalization  of  a  bank.  In  particular,  this  effect  is  likely  when  provisioning  is  not 
considered sufficient to cover loan losses. The increased uncertainty will be reflected in a higher 
risk  premium  on  banks’  funding  and  reduced  access  to  financing  (such  as  notably  wholesale 

50 Cf. ESRB (2017) op. cit. and IMF (2015a) op. cit.  
51 Carletti and Brunella (2017), op. cit. 
52 Bulgaria, Cyprus, Greece, Croatia, Ireland, Italy, Malta, Portugal, Romania, Slovenia. 
53 IMF (2015a) op. cit. 
54  Klein  (2013)  op.  cit.  shows  that  tight  financial  conditions  for  SMEs  in  Europe  have  been  a  drag  on  the  pace  of 
economic recovery. 

21 

 
 
 
 
                                                            
funding).55 To the extent that it is passed through to banks’ lending rates, credit supply declines. 
Higher funding costs and reduced credit supply again translate into less profitability. 

Overvalued  NPLs  imply  underestimation  of  risks  and  potentially  worsened  allocation  of 
credit, as non-viable businesses are kept artificially alive or restructuring is unduly delayed (so-
called  “extend  and  pretend”  practices,  see  section  2.3.1.).  In  addition,  banks  might  also  try  to 
price-in some of their loan losses through raising interest margins for performing borrowers. In 
either  case,  lending  rates  will  be  higher  and  credit  supply  lower.  Together,  this  impedes  the 
efficiency of the banking system. 

Past experience suggests that ignoring banking problems and delaying losses in the interests of 
sustaining credit will, on average, lead to a more severe contraction of credit at a later stage.56 

Non-credit supply channels 

NPLs  without  sufficient  loss  coverage  can  also  weigh  on  economic  developments  through 
channels other than credit supply. Loss forbearance, for instance, enables “extend and pretend” 
practices which may ultimately result in debt overhangs. Overextended borrowers invest too little 
and  supply  too  little  labour,  even  in  the  absence  of  financing  bottlenecks.  Unless  repayment 
difficulties  are  temporary  or  purely  strategic,  all  the  distortions  identified  by  the  extensive 
literature on debt overhang arise: overextended companies have little incentive to invest because 
any return is effectively shared with the banks holding the NPLs; overextended owners will show 
little  enthusiasm  in  maintaining  or  improving  the  houses  or  apartments  that  they  might  lose  in 
any event; and overextended households are unlikely to work harder and longer if the additional 
income  remains  insufficient  to  escape  the  debt  trap.57  All  this  reduces  economic  activity  to 
inefficiently  low  levels.  Debt  restructuring  and  partial  debt  forgiveness  that  reduce  the  debt 
burden can unlock efficiency gains with scope for debtors and creditors to both benefit; sufficient 
loan loss coverage is key for these relief measures, as it makes any resulting loss more bearable 
for the restructuring/forgiving banks. 

Failure  to  resolve  NPLs  timely  also  tends  to  trap  resources  in  unproductive  uses.  Loans 
might have become non-performing because too much credit has gone into particular sectors, to 
underperforming  entrepreneurs,  or  to  poorly  selected  projects.  In  this  case,  the  efficient  way 
forward may involve recovering remaining resources from these failed investments quickly with 
a  view  to  redeploying  them  in  more  promising  areas.  A  prolonged  hold  out  for  a  recovery  of 
existing  projects,  or  of  the  value  of  the  collateral  backing  them,  might  be  inefficient  and  hold 
back economic recovery more broadly. 

2.3.  What are the problem drivers? 

2.3.1. 

Incentives  to  delay  loss  recognition  and  reduce  provisioning  levels  (“w    
  d    ”   d “ x   d   d       d”) 

LLPs reflect incurred and/or expected losses on future loan defaults and are reported in the bank's 
annual income statement. On the balance sheet, LLPs cause a decline of the carrying value of the 
loans and a corresponding decline of the bank's equity (see section 2.1.1.). 

In particular when their regulatory capital levels are already low,  banks may attempt to delay 
loss  recognition  and  reduce  provisioning  levels,  in  order  to  avoid  a  breach  of  capital 
requirements. Another incentive may be maintaining (or even increasing) the level of earnings to 

55 Cf. Diwan and Rodrik (1992). 
56 Ibidem. 
57 Cf. Vienna Initiative (2012) op. cit. 

22 

 
                                                            
signal financial strength. In this context and more in particular the literature review by Ozili and 
Outa58 identified the following two main motives for the under-provisioning of loan losses: 

-  A  capital  management  motive:  Banks  may  time  LLPs  to  ensure  that  they  meet  the 
regulatory  minimum  capital  requirements.  This  implies  that  the  incentives  to  reduce 
provisioning levels are high when regulatory capital levels are already low.59 Capital 
the  co-movement  between  reported 
management  of 
provisioning levels and the growth rate of GDP, as bank capitalization rates are more 
likely to be stressed during economic downturns.60 

this  kind  could  reduce 

-  A  signalling  motive:  Banks  may  set  the  level  of  LLPs  to  signal  some  information 
about the quality of their loan portfolio, in particular as regards NPLs, and/or to signal 
information about its future earnings prospect.61 Banks may, in some cases, prioritise 
distributions  to  shareholders  over  increases  in  the  coverage  of  NPLs  through 
provisioning. 

Particularly  when  the  economic  outlook  is  positive,  banks  may  also  have  incentives  to  delay 
loss  recognition  and  hold  onto  their  NPLs  in  the  hope  that  the  assets  would  recover 
   u       (“w       d     ”).  They  may  in  some  instances  be  overly  optimistic  regarding  NPL 
recognition  and  their  provisioning  levels,  depending  on  their  assessment  of  the  final  expected 
recovery value (including the underlying collateral) or the sustainability of forborne loans and the 
assessment of loan management costs for the bank.62 

Finally, b  k  m   h                                 “    b   ” N L       d          d    
delay loss recognition on these loans, or in the context of a close relationship with the client 
(     k  w     “ x   d   d       d”). This means that credit is allocated to barely surviving 
firms (“zombie companies”) at the expense of firms that have a viable future. In this vein, IMF 
staff63  assesses  the  impact  of  NPL  sales  on  the  amount  of  capital  that  would  be  freed  for  a 
representative  sample  of  European  banks.  Micro-level  analysis  on  corporate-bank  relations 
suggest  that  corporate  investment  is  reduced  both  by  self-restriction  by  corporates  in  debt 
overhang and by a change in behaviour of banks with weak balance sheets.64 

2.3.2.  Excessive discretion in NPL recognition and provisioning policies across the 

Union 

LLPs  recognised  by  banks  for  NPLs  in  accordance  with  the  applicable  accounting 
framework  might  not  always  be  adequate  from  a  prudential  perspective,  which  has  a 
different  scope,  objective  and  purpose.  For  instance  the  IFRS  apply  to  undertakings  from 
various industries and are based on the principles of neutrality and faithful representation of the 
underlying  economic  transactions  at  the  reporting  date  (point-in-time).  On  the  other  hand,  the 
CRD/R  only  applies  to  credit  institutions  and  investment  firms  and  is  based  on  a  risk-based 
approach, ultimately aiming at the stability of individual institutions through the economic cycle 
and of the financial system as a whole. 

58 Ozili and Outa (2017) "Bank loan loss provisions research: a review", Borsa Istanbul Review vol. 17, 144-163. 
59 Bank managers' awareness of the consequences associated with violating minimum capital requirements is argued to 
create strong incentives to use their discretion to lower LLPs estimates to increase the bank's regulatory capital ratio 
above the minimum limit. 
60 Evidence in favour of this hypothesis is provided by Ahmed et al. (1999) for the case of US banks during 1986-1995. 
Consistent  with  a  capital  management  motive,  Huizinga  and  Laeven  (2012)  find  that  during  the  crisis  in  2008  US 
banks with large exposures to mortgage backed securities that had declined in value displayed relatively low LLPs.  
61  For  instance,  Kanagaretnam,  Lobo,  and  Mathieu  (2003)  find  that  managers  of  undervalued  banks  use  LLPs  to 
increase the level of earnings to signal banks' future earnings prospects. 
62 Cf. FSC, (2017) op cit. 
63 Cf. IMF (2015a) op. cit. 
64 FSC (2017) op. cit, with reference to Kalemli-Ozcan et al. (2015). 

23 

 
 
                                                            
IFRS 9 is expected to bring much closer alignment with the prudential standards than IAS 
39,  and  to  contribute  to  address  the  issue  of  delayed  and  inadequate  provisions,  as  it 
operates  on  an  “expected  loss”  approach  (see  Background  Information).65  The  new  standard 
leaves, however, room for discretion in determining the expected credit losses on performing and 
non-performing loans including the underlying valuation of collaterals66 and, by consequence, in 
the  determination  of  provisions.67  IFRS  9  sets  more  general  principles  and  approaches  for 
determining LLPs opposed to detailed rules. However, the management discretion is not absolute 
but framed by requirements within the standard, supervisory guidance, supervision and statutory 
audit.68 

Despite this framing there is nevertheless discretion within IFRS 9 which in practice could 
lead to lower levels of credit loss provisions, in particular when valuing collateral or third 
party  guarantees  for  secured  loans.  Therefore,  IFRS  9  cannot  fully  ensure  that  banks  will 
ultimately create sufficient levels of credit loss provisions for non-performing loans. 

At the same time, it is important to recall that LLPs are not always estimated in accordance 
with  the  same  accounting  standards:  in  several  EU  countries  some  banks  have  to  apply 
national GAAPs (instead of IFRS) which might follow a different approach. 

2.3.3.  Other drivers for insufficient loan provisioning (out of scope) 

As  also  pointed  out  by  stakeholders  in  the  context  of  the  targeted  consultation,  a  number  of 
further factors, which are not addressed here, may influence banks’ provisioning policies. 

Large  discrepancies  exist,  for  instance,  in  the  characteristics  of  national  legal  and  judicial 
frameworks as regards collateral enforcement. Differences may emerge within countries, too: 
while  civil  law  and  procedures  are  formally  the  same  across  the  national  territory,  the 
effectiveness  of  the  court  system  may  vary  widely,  depending  upon  local  jurisdictional  court 
proceedings.69  The  Commission’s  initiative  on  AECE  identifies  the  associated  problems  and 
proposes solutions. 

National tax regimes can also play a decisive role for provisioning policies. In some countries, 
charge  offs  and/or  losses  as  a  result  of  higher  provisions  are  not  eligible  (or  are  subject  to  a 
certain cap) as deductions for income tax purposes.70 

65 IFRS 9 requires banks to make provisions against performing (and not impaired) assets from the date of origination 
leading to higher amounts of provisions. 
66 The lack of standardised valuation approaches was found being detrimental for the quality of impairment 
calculations (cf. FSC 2017 op. cit.). 
67 Cf. IMF (2015a) op. cit. and IMF (2014) "Supervisory Roles in Countries implementing IFRS". 
68 For example, for determining expected credit losses IFRS 9 uses as a rebuttable assumption that loans are non-
performing when they are more than 90 days past due, and that changes in the value of collateral have to be considered 
for determining an increase in credit risk. The EBA has issued guidelines68 on accounting for expected credit losses 
under IFRS 9 which further frame the discretion for banks when determining credit loss provisions so as to ensure 
timely, adequate and comparable credit loss provisioning (see EBA (2017) "Guidelines on credit institutions’ credit 
risk management practices and accounting for expected credit losses"). 
69 Cf. Carletti and Brunella (2017), op. cit. and references therein. 
70 Ibidem: “For example, until recently the tax treatment in Italy penalized banks that wrote off problem loans more 
aggressively, allowing tax deductibility for write-offs only in the state of insolvency. Tax deductibility of LLPs was 
limited to 0.3% of outstanding loans, a clear disincentive to provisioning (IMF (2015a) op cit.). A 2013 reform allowed 
provisions and write-offs to be fully deducted in equal instalments over five years, and with a higher tax rate; In June 
2015, this period was further shortened to a year. To take another example, Spain recently eliminated taxes on debt-to-
equity swaps in a similar move to encourage banks to recognize losses from impaired assets”. 

24 

 
                                                            
2.4.  How will the problem evolve? 

Without policy intervention, banks will still have incentives and ample discretion to excessively 
delay loss recognition and reduce provisioning levels. 

H              d           b         h     gum      h       “w   -and-   ”         h     
detrimental  in  the  longer  run.71  Experience  suggests  that  ignoring  banking  problems  in  the 
interests of sustaining credit in the short run will, on average, lead to a more severe contraction of 
credit  at  a  later  stage.  Whilst  recovery  in  the  real  economy  has  already  been  followed  by  a 
reduction in NPL levels and ratios, the reduction of the stock of NPLs has been rather slow and 
the  recovery,  particularly  in  some  of  the  high-NPL  countries,  remains  fragile.  As  the  linkages 
between growth and NPLs work in both directions, it is unclear whether growth would be able to 
overcome  the  adverse  effects  on  the  real  economy  caused  by  the  large  stock  of  NPLs.72  In  the 
absence  of  action  to  address  the  problem  of  the  high  stock  of  existing  NPLs  together  with 
prudential rules for the flow of new NPLs risks to financial stability may materialise. While the 
treatment of the existing stock and the new flow requires a different set of actions, the problem 
for  financial  stability  and  growth  would  evolve  as  accumulated  effect  of  old  and  new  NPL. 
Finally,  through  important  cross-over  spill-overs  in  a  deeply  integrated  area  like  the  EU  and 
especially the EA the future NPL problems in one part of the banking sector can have negative 
impact on other parts of the system. 

The implementation of IFRS 9 is expected to lead to higher provisioning levels, but given, inter 
alia,  its  principle-based  approach,  it  might  not  suffice  to  effectively  prevent  the  build-up  of 
insufficiently covered NPL stocks on EU banks’ balance sheets. Supervisory action, in particular 
the  application  of  Pillar  2  measures,  will  help  address  specific  NPL-related  risks  of  individual 
banks. However, it might not prevent the build-up of insufficiently covered NPLs on an EU-wide 
basis  as  long  as  there  no  harmonised  (minimum)  treatment  (being  applicable  across  MSs  and 
banks). 

When there is insufficient regulatory framing, banks might accordingly take a passive (“wait and 
see”)  approach.  Attempting  to  avoid  or  delay  loss  recognition,  insufficiently  provisioned  NPLs 
would likely pile up on banks’ balance sheets, which in turn would undermine banks’ financial 
soundness and pose risks to financial stability at whole. This approach would also affect future 
lending, which could be granted under suboptimal lending standards, if the stock of NPLs does 
not  imply  significant  costs  for  the  bank  when  loans  are  non-performing.  The  same  cycle  could 
thus  constantly  be  repeated  over  time  to  the  detriment  of  financial  stability,  real  economy 
financing and growth and the public sector might be called upon to support the banks when they 
are in difficulties. 

71 Cf. ESRB (2017) op. cit. 
72 Cf. ESRB (2017) op. cit. and IMF (2015a) op. cit. 

25 

 
 
 
                                                            
Figure 12: Problem tree 

26 

                                                                                                                           Drivers Problem Consequences  Driver 1 Incentives to delay loss recognition and reduce provisioning levels (“wait and see” and “extend and pretend”) Drivers out of scope Cross-country differences in national insolvency frameworks, court system effectiveness, tax regimes Problem 1 Build-up of under-provisioned NPLs  Consequence 2 Impaired credit provision with negative impacts on real economy financing and growth Consequence 1 Negative impacts on EU banks’ financial soundness and financial stability  Problem 2 “Pockets of risks” in EU banking sector and potential spill-over  Driver 2 Excessive discretion in NPL recognition and provisioning policies across the Union   
 
 
 
3.  WHY SHOULD THE EU ACT? 

3.1.  Legal basis 

Article  114  of  the  Treaty  on  the  Functioning  of  the  European  Union  (TFEU)  confers  the 
European Parliament and the Council the competence to adopt measures for the approximation of 
the  provisions  laid  down  by  law,  regulation  or  administrative  action  in  Member  States  which 
have as their object the establishment and functioning of the internal market. Article 114 TFEU 
allows  the  EU  to  adopt  measures  (such  as  prudential  requirements  for  institutions)  that 
relate to the functioning of banking and financial services markets and are meant to ensure 
the financial stability of the operators on those markets as well as a high level of protection 
of investors and depositors. 

3.2.  Subsidiarity: Necessity and added value of EU action 

The previous section has shown that discretional (“too little and too late”) recognition of losses 
on  NPLs  ultimately  has  several  negative  effects  on  banks’  financial  soundness  and  financial 
stability of the banking system as a whole. 

associated  with 

Some MSs have established concrete provisioning rules for 
banks'  NPLs,  while  a 
few  others  have  adopted 
provisioning guidelines (see Table 1). In those MSs, as well 
as several third countries, provisioning requirements played an 
important  role  in  successfully  dealing  with  both  (aged)  NPL 
stocks  and  (new)  NPL  flows  (see  detailed  overview  in 
Annex 4).73  Still,  these  rules  are  quite  divergent  –  thereby 
hampering  comparability of capital ratios  – and do not cover 
the 
under-provisioned  NPLs 
risks 
comprehensively. 
Also,  MSs  have  only  limited  scope  to  introduce  generally 
applicable and legally binding provisioning requirements. The 
specification of IFRS, which are global standards and applied 
by  the  vast  majority  of  larger  banks,  is  ultimately  in  the 
competence  of  the  IASB.  On  the  prudential  side  again,  MSs 
are  not  entitled  to  impose  prudential  minimum  requirements 
(including  with  regards  to  NPLs),  such  as  deductions  from 
regulatory  capital,  which  are  directly  applicable  to  credit 
the 
institutions,  as 
framework) is subject to maximum harmonisation throughout 
the 
therefore  only  regulate 
prudential  provisioning  for  specialised  institutions  which  are 
not  subject  to  EU  regulation.  The  current  EU  prudential 
framework however does not provide for a common minimum 
treatment with regards to incurred/expected losses on NPLs. 
As  explained  in  the  Background  Information  section,  CAs  in 
charge of supervising institutions in the EU have the power to 
influence a bank’s provisioning policy and to require specific 
adjustments  to  the  own  funds  calculations  on  a  case-by-case 
basis (so-called “Pillar 2” of the framework). The application 
of  Pillar  2  measures  will  help  address  specific  NPL-related 
individual  banks.  However,  no  harmonised 
risks  of 

this  area  (so-called  “Pillar  1”  of 

internal  market.  MSs  can 

Table 
requirements in EU28 (yes/no) 

1:  Minimum 

provisioning 

MS 

AT 

BE 

BG 

CY 

CZ 

DE 

DK 

EE 

EL 

ES 

FI 

FR 

HR 

HU 

IE 

IT 

LT 

LU 

LV 

MT 

NL 

PL 

PT 

RO 

Minimum provisioning 
requirements in force? 
no 

no 

no 

no 

yes 

no 

no 

no 

no 

yes 

no 

no 

yes 

yes 

no 

no 

no 

no 

yes 

no 

no 

yes 

yes 

yes 

73 Cf. FSC  (2017) op cit. ; IMF (2015a) op cit.; World Bank (2014) "Report on loan classification and provisioning" 
and Inter-American Development Bank (2011) "Report on provisioning requirements in Latin America". 

27 

 
 
                                                            
(minimum)  treatment  (being  applicable  across  MSs  and 
banks)  can  be  imposed  by  supervisors.  In  absence  of  an  EU 
regulation,  it  is  therefore  not  possible  to  address  the  issue  of 
under-provisioning  of  NPEs  on  an  EU-wide  and  systemic 
basis. 

SE 

SI 

SK 

UK 

no 

yes 

no 

no 

Legislative  action  on  the  EU  level  would  require  all  institutions  established  in  the  EU  to 
cater for incurred and expected losses on newly originated loans that turn non-performing 
at  a  common  prudential  minimum  level  –  irrespective  of  the  applicable  accounting 
standards  and  the  location  of  the  bank  and  its  supervisor.  Such  minimum  coverage 
requirements  would  act  as  “prudential  backstops”  putting  automatic  EU-wide  brakes  on  the 
build-up  of  future  NPLs  without  sufficient  loan  loss  coverage  and  thus  strengthen  banks’ 
financial soundness and ability to lend. 

EU  wide  action  would  also  reduce  potential  spill-over  effects  within  the  Union.  As  set  out 
above  (section  2.1.2)  the  high  interconnectedness  within  the  EU  (and  especially  EA)  financial 
system  creates  a  significant  danger  of  spill-overs  entailing  systemic  risks  which  are  better 
addressed at EU level. 

On this basis, the EU has a right to act to ensure the financial stability of financial market 
operators as well as a protecting investors and depositors in banks. 

Due to the lack of common prudential rules on NPL  provisioning actual loss coverage for 
NPLs  may  vary  across  banks  in  different  jurisdictions  even  if  they  bear  the  same 
underlying risk (defined as a function of the type, location, collateralisation, age etc. of the 
exposure). This may limit the cross-country comparability of capital ratios and undermine their 
reliability and thereby the single rulebook, a cornerstone of the Banking Union.74 Banks with the 
same  risk  profile  and  sharing  the  same  currency  would  face  different  funding  conditions 
depending  on  where  they  are  located  inside  the  EA.  Furthermore,  on  the  borrowers’  side,  two 
companies  with  identical  risk  profiles  and  the  same  currency  would  face  different  lending 
conditions  depending  on  their  establishment  in  the  EA.  As  shown  in  section  2.2.2,  lending 
availability and costs of credit to non-financial corporates is more tightly related to the level of 
NPLs in a given MSs. 

This  creates  additional  financial  fragmentation  that  hampers  one  of  the  most  important 
benefits  of  the  financial  and  monetary  union,  namely,  the  diversification  and  sharing  of 
economic risks across borders. Avoiding the accumulation of future NPLs would reduce those 
differences, hence contributing to the good functioning of monetary transmission mechanism and 
a  more  sustainable  financial  integration  process  in  the  EU.  This  would  also  contribute  to  the 
completion of the BU by putting all banks on an equal footing, reducing unnecessary differences 
in banks' practices, increasing comparability, facilitating market discipline and promoting market 
confidence. 

74 Bank capital without sufficient loan loss coverage is overstated and conceals the issues associated with credit 
deterioration. 

28 

 
 
 
 
 
                                                            
4.  OBJECTIVES: WHAT IS TO BE ACHIEVED? 

4.1.  General objectives 

4.1.1.  Reduce financial stability risks  

As discussed in section  2.2.1, high levels of insufficiently covered NPLs can become a serious 
threat to financial stability. The first general objective of this initiative is to limit these risks to 
financial  stability  by  avoiding  the  build-up  or  excessive  increase  of  insufficiently  covered 
NPLs in the EU banking system. 

The  risks  to  financial  stability  have  also  an  important  geographical  dimension.  While  cross-
border  banking  brings  important  stability  and  risk-sharing  benefits,  through  its  effects  on  risk 
diversification,  it  also  strengthens  channels  of  propagation  of  shocks  from  one  jurisdiction  to 
others. It is thus paramount to ensure that build-ups of under-provisioned NPLs are prevented to 
arise  in  any  jurisdiction.  Pockets  of  NPL  risk  represent  in  fact  a  risk  for  other  jurisdiction  via 
spill-overs.  By  introducing  statutory  backstops,  this  initiative  aims  at  capping  the  levels  of 
under-provisioned NPLs that can arise in EU MSs thereby ensuring that no new "pockets 
of NPL risks" with spill-over potential in stressed market conditions arise. 

4.1.2.  Support stable financing of the real economy and growth 

Banks saddled with NPLs tend to face higher funding  costs and capital requirements and 
lower  resource  efficiency  and  profitability75.  This  limits  their  ability  to  extend  new  credit. 
Persistently  weak  loan  portfolios  are  thus  a  potential  drag  on  financing  firms,  households  and 
ultimately economic growth. Indeed, recoveries after financial crises are found to be particularly 
protracted because the economy faces a credit crunch due to impaired financial intermediation76. 
The impaired credit supply clearly weighs on aggregate demand and investment.  

Hence, the second general objective of this initiative is to ensure institutions have sufficient 
loss  coverage  for  NPLs,  hence  protecting  their  profitability,  capital  and  funding  costs  in 
stressed  times.  This  is  particularly  important  in  the  EU  where  financial  intermediation  is  still 
largely  dominated  by  banking  institutions.  Coupled  with  deeper  and  stronger  capital  markets 
thanks  to  the  CMU  initiative,  this  should  ensure  that  stable,  less  pro-cyclical  financing  is 
available to EU households and firms. 

It is worth noticing that more stable credit provision and higher growth increase debtors' wealth 
and ability to repay, thereby reducing the probability of a loan being defaulted and the expected 
losses  in  such  cases  while  improving  banks'  balance  sheets.  In  other  words,  higher  growth 
reduces financial stability risks. Lower financial stability risks reduce funding costs for banks and 
the  economy,  thereby  fostering  economic  growth.  Hence,  the  two  general  objectives  of  this 
initiative are mutually reinforcing.  

4.2.  Specific objectives 

4.2.1.  R du     b            m   m     “w       d     ”    d  “ x   d    d        d” 

strategies 

The  initiative  aims  at  reducing  banks'  discretion  with  regards  to  the  recognition  of  and 
provisioning for  NPLs  (problem  driver  2).  Such  discretion  has  indeed  provided  room  for  “wait 

75 See, among others, Vienna Initiative (2012), op. cit. and ESRB (2017), op. cit. 
76 See Abiad et al. (2011) op. cit. 

29 

 
                                                            
and see” and “extend and pretend” strategies whose negative effects on banks profitability and, in 
severe cases, viability manifest itself during economic downturns. 

4.2.2.  R du                  m   m    “w      d    ”   d “ x   d   d       d” 

strategies 

By  removing  the  possibility  to  postpone  excessively  the  tackling of  NPLs,  based  on,  inter  alia, 
optimistic expectations of future improvement in loans performance, the legislative intervention 
would  incentivise  bank  management  to  act  proactively  and  pre-emptively.  In  other  words, 
knowing  that  NPLs need  to  be covered within a limited  time frame would incentivise banks to 
start implementing  NPLs resolution  strategies even  before these become  mandatory (i.e.  before 
the date when the minimum coverage requirement becomes applicable). In this way, the initiative 
will change banks conduct towards more forward-looking practises (i.e. tackling problem driver 
1). 

30 

 
 
 
5.  WHAT ARE THE AVAILABLE POLICY OPTIONS? 

5.1.  What is the baseline from which options are assessed? 

The baseline for comparing policy options is the current state of play, with no further legislative 
change at EU level. Loss coverage for NPEs would mainly be determined by two already existing 
instruments (as explained in detail in the background information): 

-  Application  of  either  IFRS  9,  which  will  better  address  the  issue  of  delayed  and 

inadequate provisions, or, where applicable, national GAAPs; and 

-  Supervisory action, in particular Pillar 2 measures allowing bank supervisors to require 
more provisioning within the limits of the applicable accounting standards on a case-by-
case basis. 

The implementation of IFRS 9 is expected to lead to higher provisioning levels particularly for 
performing exposures (classified in Stage 1 and Stage 2), whereas for NPEs (classified in Stage 
3), the new accounting standard will largely keep the same treatment as IAS 39 and is expected to 
lead only to a minor increase in provisions of around 5% on average (see section 6.). Given, inter 
alia,  its  principle-based  approach  for  determining  credit  loss  provisions  (as  opposed  to  non-
discretionary  rules),  it  might  not  suffice  to  effectively  prevent  the  build-up  of  insufficiently 
covered  NPL  stocks  on  EU  banks’  balance  sheets.  At  the  same  time,  in  several  EU  countries 
some banks have to apply national GAAPs as their accounting standards (instead of IFRS) which 
might  follow  a  different  provisioning  approach.  Hence  the  accounting  framework  might  not 
ensure that EU banks will ultimately create sufficient levels of credit loss provisions for NPLs. 

Existing  and  forthcoming  supervisory  guidance  by  the  ECB/SSM77  and  the  EBA78  on  NPE 
management will urge banks with elevated levels of NPEs to implement effective strategies for 
tackling those exposures and can thus be expected to help reduce (primarily the stock of) NPEs 
on  affected  banks’  balance  sheets.  Furthermore,  the  ECB/SSM79  will  publish  supervisory 
expectations when assessing a bank’s levels of loan loss coverage for new NPEs as part  of the 
supervisory  review  and  evaluation  process  in  the  context  of  Pillar  2.  Where  the  supervisor 
including the ECB/SSM ascertains on a case-by-case basis that the provisioning policy chosen by 
the institution is not adequate or sufficiently prudent from a supervisory point of view, it may set 
binding  supervisory  measures.  The  application  of  Pillar  2  measures  will  help  address  specific 
NPL-related  risks  of  individual  banks.  However,  no  harmonised  (minimum)  treatment  (being 
applicable across MSs and banks) can be imposed by supervisors. 

In  absence  of  an  EU  regulation,  it  is  therefore  not  possible  to  address  the  issue  of  under-
provisioning of NPEs on an EU-wide and systemic basis. 

77 In March 2017 the ECB published guidance to banks on non-performing loans, which provides information on how 
banks are expected to manage NPLs. 
78 In accordance with the NPL Action Plan the EBA will issue guidelines on NPE Management which will be 
consistent with the ECB’s guidance on NPLs applicable to significant credit institutions. The EBA guidelines will have 
an extended scope and will hence apply to all banks in the Union. 
79 See ECB (2017) "Addendum to the ECB Guidance to banks on nonperforming loans", available at: 
https://www.bankingsupervision.europa.eu/legalframework/publiccons/pdf/npl2/ssm.npl_addendum_draft_201710.en.
pdf. 

31 

 
 
 
                                                            
5.2.  Description of the policy options 

5.2.1.  Common principles applying to all three options 

Statutory  prudential  backstops  would  influence  banks'  prudential  figures.  They  would  not  have 
any  direct  impact  on  the  banks'  financial  statements  which  would  remain  to  be  determined  by 
accounting  rules.  Statutory  prudential  backstops  would  consist  of  two  main  elements:  (i)  a 
requirement for banks to cover up to common minimum levels the incurred and expected 
losses  on  newly  originated  loans  once  such  loans  become  non-      m  g  (“m   mum 
      g     qu   m   ”),    d  (  )  wh      h   m   mum        g     qu   m              m  ,    
deduction  of  the  difference  between  the  level  of  the  actual  coverage  and  the  minimum 
coverage from Common Equity Tier 1 (CET1) items.  

Different coverage requirements, depending on the classification of the NPLs as "unsecured" or 
"secured" are considered. NPLs or part of NPLs, covered by eligible credit protection as set out 
in the CRR are considered as secured. On the other hand, NPLs, or parts of NPLs, which are not 
covered by an eligible credit protection are categorised as unsecured. A loan only partly covered 
with collateral would be considered as secured for the covered part, and as unsecured for the part 
which is not covered with collateral.  

In  principle,  non-performing  unsecured  credit  exposures  and  non-performing  credit  exposures 
secured by collateral could be treated in the exact same way. However, these types of exposures 
have different characteristics in terms of risk. Secured NPLs are in general less risky for a bank 
than unsecured NPLs as the credit protection securing the loan gives the lender a specific claim 
on an asset or against a third party without reducing his/her general claim against the defaulted 
borrower.80 On the contrary, in case an unsecured loan becomes non-performing the bank would 
not have such specific preferential claim. Recovery rates are on average higher for secured NPLs 
than for unsecured ones.81 However, it takes some additional time to enforce the credit protection 
and,  where  applicable,  realise  the  collateral.82  Unsecured  NPLs  should  therefore  require  higher 
and timelier minimum coverage by the creditor bank than secured NPLs. However, after a certain 
number  of  years  without  being  successfully  enforced  (i.e.  the  collateral/guarantee  could  not  be 
realised),  the  credit  protection  should  not  be  seen  as  effective  anymore.  In  such  case,  full 
coverage  of  the  exposure  amount  of  secured  NPLs  is  deemed  necessary.  Therefore,  the  time 
period for unsecured NPLs is not the same than for secured ones. 

Given  the  considerations  above,  the  minimum  coverage  requirement  would  be  a  function 
of: 

(i) the time period an exposure has been classified as non-performing – since the longer the 
exposure has been non-performing, the lower is the probability to recover its value83;  

(ii) and, where available, the level of credit protection (collateral and guarantees) held for 
this  NPL  (applying  the  relevant  eligibility  criteria  set  out  in  the  CRR  for  credit  risk 
mitigation  purposes)  –  since  credit  protection  increases  the  probability  to  recover  the 
exposures value. 

The chosen approach should ensure that the level of credit protection follows a prudent approach, 
in  particular  regarding  assumptions  pertaining  to  recoverability  and  enforceability84.  To  ensure 

80  At  face  value,  the  value  of  the  assets  given  as  collateral  can  in  general  be  sufficient  to  cover  the  value  of  the 
outstanding debt obligation. However in practice a security right has a reduced value to a secured creditor if it cannot 
be enforced effectively and efficiently. 
81 See for example Gupton et al. (2000), Banca d’Italia (2017). 
82 Cf. ESRB (2017) op. cit. and IMF (2015a) op cit. 
83 Recovery rates decline as the age of the NPEs increase: the  longer they remain on banks’ balance sheets, the less 
banks succeed in recovering. 

32 

 
                                                            
consistent  outcomes  across  banks,  a  common  methodology,  including  possible  minimum 
requirements  for  re‐valuation  in  terms  of  timing  and  ad  hoc  methods,  would  have  to  be 
developed85  (e.g.  by  the  EBA).  In  cases  where  institutions  fail  to  perform  prudent  collateral 
valuation alongside the defined methodology or the valuation has not been updated on a timely 
basis, the whole exposure should be treated as unsecured from a prudential perspective.  

The  following  items  would  be  eligible  for  compliance  with  the  minimum  coverage 
requirements: 

a) provisions recognised under the applicable accounting framework ("credit risk adjustments"), 
i.e.  the  amount  of  specific  and  general  loan  loss  provision  for  credit  risks  that  has  been 
recognised in the financial statements of the institution; 

b) additional value adjustments for fair-valued assets; 

c)  other  own  funds  reductions.  For  instance,  institutions  have  the  possibility  to  apply  higher 
deductions from their own funds than required by the regulation; and 

d)  for  banks  calculating  risk-weighted  assets  (RWAs)  using  the  internal  ratings‐based  (IRB) 
approach, the regulatory expected loss shortfall which is already deducted from own funds. 

Only where the sum of the amounts listed under a) to d) does not suffice to meet the applicable 
minimum coverage requirement, the prudential  backstops would apply. The difference between 
the two (uncovered exposure amount or “coverage gap”) from CET1 items would be deducted. 
The  deduction  would  ensure  that  the  risks  associated  with  NPLs  are  appropriately  reflected  in 
banks' CET1 capital ratios in one way or another. 

Figure 13: Main components and functioning of the statutory backstop proposal 

Source: European Commission, EBA 

Furthermore,  the  following  common  features  would  apply  to  all  three  policy  options 
presented in the remainder of this section: 

  Common  definition:  NPLs  would  be  defined  in  CRR  using  the  already  existing  definition 

established by the EBA for supervisory reporting86. 

  Pillar 1 deduction: the common backstop would be a Pillar 1 deduction (in case the minimum 
coverage  requirement  is  not  met),  i.e.  it  will  apply  mandatorily  to  all  banks  before 
supervisors  assess  whether  banks  need  to  hold  additional  own  funds  for  Pillar  2  purposes. 
The  sequence  would  be  to  first  apply  the  accounting  provisions  in  accordance  with  the 

84 Deficiencies in the approaches employed by banks have been found most notably for immovable property collateral 
(cf. ECB [2014]). 
85 EBA (2016). 
86 Implementing Regulation (EU) No. 680/2014. 

33 

 
 
                                                                                                                                                                                 
applicable accounting framework, then the statutory backstops and last a Pillar 2 requirement 
in case the supervisor sees a need to go further than the statutory backstops already require. 

  Safeguards:  the  design  of  a  prudential  backstop  should  ensure  that  it  does  not  lead  to  any 

"double-counting" of provisioning or risks. 

  Time  calibration:  given  that  recovery  times  for  secured  and  unsecured  NPLs  differ 
empirically, the time period after which full coverage for NPLs would be required should be 
different  depending  on  whether  the  NPLs  are  secured  or  not.  In  case  of  unsecured  NPLs, 
banks should fully cover them more quickly than secured NPLs. The FSC report87 suggests a 
time  period  of  2  years  for  unsecured  NPLs  after  the  classification  of  the  exposure  as  non-
performing. For secured NPLs, the proposed time period envisaged by the FSC report ranges 
from 6 to 8 years. 

  Time calibration for unsecured NPLs: 

According to some private stakeholders in their answer to the targeted consultation, imposing a 
full  coverage  of  unsecured  NPLs  2  years  after  their  classification  as  non-performing  would  be 
overly conservative. In some cases institutions will fully recover unsecured loans after three or 
four years. These stakeholders have argued that it would be unduly strict to require full coverage 
for  NPLs  which  have  been  forborne  for  a  period  beyond  2  years  and  where  the  counterparty 
meets its obligations. 
However,  a  time  period  of  2  years  for  unsecured  NPLs  appears  to  be  justified  for  two  main 
reasons:  

i) 

in a number of third countries requiring full provisioning or write-off of NPLs, non-
performing  exposures have to be fully provisioned and/or written off earlier than 2 
years (see Figure 14 and Annex 4). In the EU, the length after which unsecured NPLs 
have to be fully provisioned or written-off (where such requirement exists) varies but 
evolves  on  average  close  to  2  years  after  the  classification  as  non-performing  (it  is 
for instance 180 days in Romania and less than 2 years in Spain). Choosing a time 
period of 2 years before full coverage of unsecured NPLs would be in line with the 
current practices in- and outside the EU; 

ii)  under this option, any amount that has been deducted and which is finally recovered 
afterwards would be added back to the banks' CET1. In this way, there would be no 
undue provisioning of loans which are actually paid back.  

A  time  period  of  2  years  would  also  be  in  line  with  the  FSC  recommendations.  All  public 
stakeholders answering to the consultation support such time calibration. Furthermore, the ECB 
in  its  role  as  single  supervisor  of  EA  banks  (ECB/SSM)  considers  a  timeframe  of  maximum  2 
years  for  a  full  provisioning  of  unsecured  NPEs  as  a  benchmark  when  assessing  a  bank’s 
provisioning policy.88 

87 Cf. FSC (2017). 
88  The ECB  Banking  Supervision is  currently consulting  on  how  Pillar  2  powers  could  be applied to  address under-
provisioning of NPLs (cf. ECB [2017]). 

34 

 
 
 
 
 
                                                            
Figure 14: Provisioning requirements for unsecured NPLs and non-collateralised parts of secured NPLs (days of past 
due after which a 100% loan provisioning is required; excluding EA countries) 

Note: 

For USA and Brasil data refer to write-offs. Write-offs after 180 dpd in US (only household loans), in Brazil, 
distressed loans are written off after 180 dpd. In Argentina, Chile, Colombia, Ecuador, Mexico and Peru, for 
the  computation  of  loan  loss  provision  the  applicable  regulations  differentiate  by  type  loans  (Consumer, 
Commercial,  Microcredit  and  Mortgage  loans).  For  these  countries,  the  figure  above  reports  only  the 
requirement for corporate loans. 

  Time calibration for secured NPLs: 

As  far  as  the  time  calibration  for  secured  NPLs  provisioning  is  concerned,  the  consultation 
showed  divided  views.  While  private  stakeholders  held  that  6-8  years  as  proposed  by  the  FSC 
was overly conservative, public stakeholders support this timeframe. This timeframe seems  also 
proportionate  in  view  of  the  average  foreclosure  period  which  ranges  from  3  to  5  years  in  the 
majority of EU MSs.89 Furthermore, the ECB/SSM considers a timeframe of maximum 7 years 
for  a  full  provisioning  of  secured  NPEs  as  a  benchmark  when  assessing  a  bank’s  provisioning 
policy.90  There  are  also  solid  (macro-)economic  arguments  to  choose  a  time  period  between  6 
and 8 years. Literature on the length of economic downturns caused by financial crises91 suggests 
that economic conditions such as GDP growth, unemployment levels and debt increases reach the 
peak  of  distress  around  5  years  after  the  onset  of  a  crisis.  The  following  recovery  to  pre-crisis 
levels takes on average 3 more years. In order to avoid pro-cyclical effects by forcing banks to 
provision during the depth of the crisis, full provisioning of the secured part should therefore not 
be triggered before 6 to 8 years after a secured loan is identified as non-performing. Furthermore, 
the  introduction  of  automatic  backstops  has  the  effect  of  mitigating  pro-cyclicality  of  credit 
provision by reducing discretion in the application of NPLs recognition and provisioning. In this 
way, it prevents the emergence of "outlier institutions", i.e. banks whose NPLs levels grow to a 
level  which  is  endangering  their  solvency  and  impairing  their  ability  to  provide  credit.  These 
institutions' problems typically become manifest in stressed times which leads to further declines 
in credit provisioning, growth and employment.  

In its response to the Commission's call for advice the EBA analysed the differences in terms of 
impact of a full coverage requirement for secured NPLs after 6, 7 or 8 years (for an overview of 
the  methodology  and  caveats  applied  see  section  6).  As  expected,  the  cumulative  impact  is 
decreasing with the years by when the full coverage is required for secured NPEs, i.e. the overall 
cumulative  impact  is  lowest  for  the  8  yeas  calibration.  The  difference  between  the  three 
calibration is however small and in the region of 10 basis points (bps). 

89 Cf. ESRB (2017) op. cit. and IMF (2015a) op. cit. 
90 Cf. ECB (2017). 
91 The most quoted papers of this literature are: Reinhart and Rogoff (2009): "The aftermath of financial crises", NBER 
WP14656  (2009)  and  Reinhart  and  Rogoff  (2014):  "Recovery  from  financial  crises:  evidence  from  100  episodes" 
American Economic Review: Papers & Proceedings 2014, 104(5): 50–55.  

35 

 
 
 
                                                            
For all these reasons the starting point for the design of all policy options would be: (i) full 
coverage of unsecured NPLs after 2 years, and (ii) full coverage of secured NPLs after 6 to 8 
years. 

The  following  three  policy  options  to  tackle  under-provisioned  NPLs  are  considered  in  the 
remainder of this section: 

i)  Option  1:  full  coverage  of  unsecured  and  secured  NPLs  at  the  end  of  defined  time 

periods without any coverage requirement beforehand; 

ii)  Option  2:  gradual  coverage  requirement  starting  after  the  classification  as  non-
performing and leading to a full coverage of unsecured and secured NPLs at the end of 
defined time periods; 

iii)  Option 3: for secured NPLs, application of haircuts depending on the type of collateral 

(unsecured NPLs would be treated as under Option 1 or 2). 

5.2.2.  Option 1: Statutory backstop with end-of-period full coverage requirement 

As  explained  under  section  5.2.1.,  statutory  prudential  backstops  would  consist  of  two  main 
elements: (i) a minimum coverage requirement for banks to be compared to the actual coverage 
by  the  bank;  and  (ii)  where  the  minimum  coverage  requirement  is  not  met,  a  deduction  of  the 
difference  between  the  level  of  the  actual  coverage  and  the  minimum  coverage  (i.e.  the 
uncovered exposure amount) from Common Equity Tier 1 (CET1) items.  

For  both  secured  and  unsecured  NPLs,  it  is  proposed  under  Option  1  that  their  full  coverage 
would  be  required  at  the  end  of  a  defined  time  period,  without  any  gradual  requirement 
beforehand (and therefore no required deduction before the end of the period). As explained in 
section  5.2.1.  above,  it  is  justified  to  apply  a  shorter  period  to  unsecured  NPLs,  as  RR  are 
significantly  lower  compared  to  secured  loans.  Therefore  the  envisaged  time  period  and 
deduction mechanism are different for both types. 

Full coverage of unsecured NPLs: 

International  comparison  and  experience  gained  in  jurisdictions  in-  and  outside  the  EU  suggest 
that institutions could be required to fully cover their unsecured (parts of) NPLs two years after 
the identification of the loan as non-performing.  

This means that, where the minimum coverage requirement is not met and the backstops apply, 
institutions  would  have  to  deduct  from  their  CET1  items  the  uncovered  exposure  amount  of 
unsecured  (parts  of)  NPLs.  The  uncovered  exposure  amount  would  be  the  accounting  value 
remaining  after  specific  credit  risk  adjustments,  additional  value  adjustments,  other  own  funds 
reductions  and  deduction  of  the  regulatory  expected  loss  shortfall  related  to  the  exposure  (i.e. 
items a) to d) listed in Figure 13 above). It will ensure full prudential loss coverage of unsecured 
NPLs. 

Full coverage of secured NPLs: 

For secured NPLs, the approach would be based on an assessment whether the collateral securing 
the loan can be realised in a timely manner. Where the collateral/guarantee has not been realised 
within  a  defined  time  period  (following  the  classification  of  the  underlying  exposure  as  non-
performing), the credit protection should be considered ineffective from a prudential perspective. 
By consequence, the exposure would be treated as unsecured for the purposes of the backstops, 
irrespective of the collateral valuation. Institutions would therefore be required to fully cover the 
exposure amount after the defined time period for unsecured NPLs elapsed: in case the minimum 
coverage  requirement  is  not  met,  institutions  would  have  to  deduct  from  their  CET1  items  the 
difference  between  the  amount  covered  by  the  provisions,  additional  value  adjustments,  other 

36 

 
own funds reductions, regulatory expected loss shortfall and additional deductions (see items a) 
to d) listed above in Figure 13) on the one hand, and the minimum coverage requirement on the 
other hand.   

The requirement to have a full coverage for secured NPLs could apply at the end of the defined 
time period. 

5.2.3.  Option 2: Statutory backstop with gradual full coverage requirement 

Option 2 would be the same as Option 1 with the following modifications. 

On the one hand, abrupt and potentially harmful cliff-effects should be avoided and potentially 
pro-cyclical  effects  should  be  limited.  On  the  other hand  some  time  for  viable  forbearance  and 
possible recoveries (in particular in case of collateral held for NPEs) should be given before the 
requirements effectively bite. To achieve both goals, a gradually increasing scaling factor would 
be applied  to the minimum  coverage requirements.  Banks would have to follow  a gradual path 
towards  the  required  coverage  level  with  the  effect  that  banks  would  have  to  anticipate  the 
requirement, which under Option 1 would be applicable only at the end of the time period.  

Under option 2, either a linear or a progressive path could be applied. In case of a linear path, the 
minimum coverage level would equally increase over the years during the different time periods 
set  for  unsecured  NPLs  and  secured  NPLs.  In  case  of  a  progressive  path,  the  amount  to  be 
covered each year would be lower at the beginning of the time period and would increase over 
time. 

Progressively  phased  in  minimum  coverage  levels  would  reflect  the  observation  that  loan 
recoveries in most cases happen during the first years after its classification as non-performing, 
especially  for  secured  NPLs.  The  same  applies  for  viable  forbearance  measures.  A  progressive 
path would therefore be better aligned with the observed recovery practices.  

Institutions would have 2 years to fully cover unsecured NPLs and 6 to 8 years until full coverage 
of the gross exposure amount of secured NPLs has to be reached. In such a scenario, coverage 
levels could for instance be set as shown in Table 2: full coverage requirement is reached in two 
years for unsecured NPLs and in 8 years for secured NPLs; for both it follows either an end-of-
period (no scalar), linear or progressive path.  

Table 2:  Illustration  for  minimum  coverage  levels  for  unsecured  and  secured  (parts  of)  NPLs  applying  no  scalar 

(Option 1), a linear one or a progressive one (Option 2) 

Unsecured (parts of) NPLs 
No scalar 
0% 
100% 

Progressive 
35% 
100% 

Vintage 

Min coverage after 1y 
Min coverage after 2y 
Min coverage after 3y 
Min coverage after 4y 
Min coverage after 5y 
Min coverage after 6y 
Min coverage after 7y 
Min coverage after 8y 

Secured (parts of) NPLs 

Linear  No scalar 
50% 
100% 

Progressive 
5% 
0% 
10% 
0% 
17,5% 
0% 
27,5% 
0% 
40% 
0% 
0% 
55% 
0%/35%*/50%**  75% 
100% 

100% 

Linear 
12,5% 
25% 
37,5% 
50% 
62,5% 
75% 
87,5% 
100% 

Notes: 

* If a progressive scalar for unsecured (parts of) NPLs was applied (as secured NPEs would be considered as 
unsecured after 6 years); 
**  If  a  linear  scalar  for  unsecured  (parts  of)  NPLs  was  applied  (as  secured  NPEs  would  be  considered  as 
unsecured after 6 years). 

37 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Figure 15 visualises the different paths of the minimum coverage requirement under the end-of-
period deduction (Option 1) and the gradual deduction (option 2) for secured exposures reaching 
100% coverage after 8 years. 

Figure 15: 

Different  paths  of  the  minimum  coverage  requirement  in  the  end-of-period  deduction  (option  1) 
and gradual deduction (option 2) approach (secured exposures) reaching 100% after 8 years 

Source:  EBA (2018) 

5.2.4.  Option 3: Statutory backstop with prudential haircuts 

Option  3  is  only  considered  for  secured  NPLs,  as  this  approach  is  based  on  the  value  of  the 
collateral  or  guarantee.  The  treatment  of  unsecured  NPLs  would  remain  the  same  as  under 
Options 1 or 2 (end-of-period or gradual coverage level requirement).  

For  secured  NPLs,  the  method  to  determine  the  amount  to  be  deducted  would  be  more  risk-
sensitive  than  under  Options  1  and  2.  At  the  same  time,  option  3  would  allow  to  address  risks 
associated with the effectiveness of credit protection for NPLs in a more targeted way. 

In a first step, specific minimum levels of prudential haircuts92 on the collateral/guarantee values 
(as  determined  in  accordance  with  the  applicable  accounting  standards  and  prudential 
requirements)  of  a  secured  loan  would  be  applied.  More  specifically,  the  magnitude  of  the 
applicable haircut would depend on the form of the credit protection and the actual length of time 
to its realisation. Forms of credit protection for which credit assessments by a recognised ECAI93 
are  available,  operate  in  liquid  markets  and  show  well-established,  publicly  available  and 
sufficiently stable market prices would be subject to relatively lower initial haircut levels.  

In  a  second  step,  the  level  of  haircuts  would  gradually  increase  with  every  subsequent  year 
starting from the second year after the classification as non-performing. The longer the realisation 
of collateral takes, the more additional haircuts would apply. It will thereby reflect the increasing 

92 Prudential haircut means applying a reduction in the value of the protection recognised for prudential purposes. 
93 External Credit Assessment Institution. 

38 

 
 
 
 
 
                                                            
uncertainty  as  to  the  ultimate  recovery  values94,  accumulating  maintenance  costs95  and 
discounting.  

Table  3  sets  out  possible  minimum  haircut  levels  for  selected  forms  of  collateral  (including  a 
concrete example for commercial real estate) based on international practice for a time period of 
6  years.96  The  haircuts  increase  over  time,  therefore  increasing  the  minimum  coverage  level 
requirement. 

Table 3:  Possible minimum haircut levels for selected forms of collateral over time 

Form 
Protection97 

of 

Credit 

Initial Haircut Level 

Additional  Haircut  per 
year to realisation 

Applicable  Haircut 
after 8 years 

Financial collateral 

20%-40% 

Immovable property 
(e.g. Commercial RE) 

30%-60% 
(40%) 

Other collateral 

40%-50% 

5-15% 

5-20% 
(7,5%) 

5-20% 

60%-100% 

70%-100% 
(40%+5*7.5%=100%) 

80%-100% 

5.3 Discarded option: granting binding accounting powers to supervisors 

In the current EU rules, supervisors do not have binding accounting powers or a mandate to adopt 
binding  accounting  regulations.  The  power  is  provided  to  national  jurisdictions  for  national 
GAAPs  in  the  context  of  the  implementation  of  the  Accounting  Directive  (Directive 
2013/34/EU). With the exception of one MS (Spain), accounting powers are not granted banking 
supervisors. According to the SSM Regulation, also the ECB as competent authority for the EA 
does not have such powers, and is not entitled to change institutions' financial statements. At EU 
level,  it  is  the  European  Securities  and  Markets  Authority  (ESMA)  which  is  responsible  for 
promoting  a  consistent  application  of  IFRS  and  coordinating  national  regulators’  enforcement 
practices. 

Under  this  option,  EU  legislation  would  give  regulatory  and  horizontal  accounting  powers  to 
supervisors, both to adopt accounting texts and to enforce them. Competent authorities would be 
empowered  to  set  stricter  standards  and  require  higher  provisioning  of  NPLs  in  the  financial 
statements, and, consequently, in the prudential reporting. National supervisors would be able to 
address all banks in their jurisdiction, and not only be able to act on a case-by-case basis. 

This  option  would  entail  a  very  significant  change  to  the  current  European  framework  and  go 
much beyond the scope of solely tackling the NPLs issue. Accounting powers would encompass 
other aspects than NPLs provisioning; assessing potential unintended consequences to grant such 
powers to supervisors would require a much broader reflection outside the mandate of this impact 
assessment.  

Granting new accounting powers to supervisors would be highly challenging in terms of human 
and financial resources (recruitment and training). It would also imply modifications of the SSM 
Regulation, which would be politically and legally challenging, or to leave the competencies to 
national  authorities. In such case, it would not only  increase the  complexity of the institutional 

94 Cf. EBA (2016) "Report on the dynamics and drivers of non-performing exposures in the EU banking sector". 
95  Incurred  by  the  bank  in  relation  to  the  management  and  execution  (including,  where  applicable,  repossession  and 
disposal) of the collateral/guarantee. 
96  See  also  ECB  (2017)  "Stocktake  of  national  supervisory  practices  and  legal  frameworks  related  to  NPLs";  IMF 
(2015) op cit. and World Bank (2014) op. cit. 
97 As per the applicable eligibility criteria set out in the CRR for credit risk mitigation purposes. 

39 

 
 
                                                            
framework but also fail to harmonize the treatment of NPLs within the EU; NPLs provisioning 
would  be  tackled  through  statutory  measures  across  institutions,  but  would  remain  country-
specific. 

Besides,  financial  statements  are  used  for  other  purposes  than  prudential  reporting.  Market 
participants  assessed  them  for  investments  purposes,  or  economic  analysis.  They  are  also  the 
basis  to  determine  the  fiscal  result.  Any  direct  modification  to  the  financial  statements  would 
have to be duly justified in regards of all aspects beyond prudential matters.  

More  generally,  accounting  standards  have  different  objectives  than  banking  regulation.  They 
apply  to  all  kind  of  companies,  and  mainly  aim  to  present  a  faithful,  transparent  and  neutral 
picture of financial performance and financial position at a certain reporting date. Contrary to the 
banking rules, accounting standards do not have an objective of financial stability over the cycle 
and  are  not  inherently  risk-based.  Amending  the  accounting  framework  in  the  pursuit  of 
prudential objectives might have undesirable effects and would lead to undue complexity for all 
stakeholders.  Moreover,  IFRS  were  adopted  to  improve  the  efficiency  of  the  single  European 
capital  market.  Supervisory  induced  modifications  to  IFRS  would  impede  comparability  and 
defeat the purpose of the single capital market where banks compete with other types of entities. 

Therefore, the option to grant supervisors direct accounting powers has been discarded. 

40 

 
 
 
6.  WHAT ARE THE IMPACTS OF THE POLICY OPTIONS? 

Benefits  and  costs  of  the  three  proposed  options  are  assessed  under  this  section.  They  are 
compared  with  the  baseline  scenario  and  in  respect  of  their  effectiveness  in  terms  of  the 
objectives set out in section 4. Thereby, two specific objectives to i) reduce ability to implement 
“wait and see” and “extend and pretend” strategies and ii) to remove incentives to "wait and see" 
and  "extend  and  pretend"  strategies  will  be  assessed  against  the  background  of  the  general 
objectives  to  i)  reduce  financial  stability  risks,  and  ii)  support  stable  financing  of  the  real 
economy and growth. Other considerations will also be taken into account, such as the relative 
costs  for  institutions  (such  as  implementation  and  administrative  costs,  increase  of  capital 
requirements, etc.). 

In this way, all three options and the baseline scenario are assessed in terms of effectiveness 
in  regards  of  the  objectives,  cost  efficiency  to  achieve  them,  consistency  with  other  EU 
policies and impact on key stakeholders. A summary of stakeholders' feedback is provided for 
each option; further details on the replies to the targeted consultation (38 in total) can be found in 
Annex 2. 

6.1.  Impact on bank capital (quantitative analysis) 

In  order  to  assess  the  potential  impact  of  the  three  options  on  bank  capital,  technical 
assistance  has  been  sought  from  the  EBA.98  In  particular,  the  EBA  was  asked  to  provide 
estimates on accelerated capital needs triggered for EU banks by the prudential backstops under 
the three options, compared to the expected increases in provisions as a result of the application 
of  IFRS  9  (baseline).  Crucially,  impact  estimates  should  be  seen  as  accelerated  rather  than 
additional drags on capital in a steady state scenario, as they will either occur anyway in the form 
of  losses  (for  non-recoverable  exposures)99,  or  they  will  be  offset  by  respective  recoveries  (for 
exposures that are recovered after the backstop was applied)100. In other words, the introduction 
of prudential backstops would only alter the distribution of capital needs to cover losses on NPEs 
over time, but it would not increase their overall size. The aim of this initiative is not to increase 
capital  requirements  due  to  NPE  coverage  but  only  to  spread  such  coverage  more  evenly  over 
time instead of leaving it concentrated at the time when recognition is not deferrable any further. 

Methodology and caveats 

For this quantitative analysis a projection horizon of 20 years is foreseen, meaning that the 
impact of the backstops has been calculated over the period 2018 – 2037. The calculation of 
the impact is therefore subject to large confidence bounds. 

The sample assessed consists of 129 EU banks, 98 from the EA and 31 from non-EA MSs, as 
for  those  institutions  supervisory  reporting  in  the  needed  quantity  and  quality  is  available.  The 

98 "Call for advice to the EBA for the purposes of considering statutory prudential measures to address insufficient 
provisioning for newly originated loans once they become non-performing", available at: 
https://www.eba.europa.eu/documents/10180/2022642/EBA+Call+for+advice_NPLs_prudential+backstops.pdf/8f41cc
22-c096-4ab9-ae5c-2101de848a05. 
99 Banks need to cover non-recoverable NPLs regardless of the prudential backstop. 
100 Exposures which had been fully deducted from capital in accordance with the prudential backstop but finally were 
recovered by the bank would increase capital up to the recovered amount. 

41 

 
                                                            
credit  risk  weighted  assets  (RWAs)  of  these  institutions  account  for  around  83%  of  EU  credit 
RWAs101. 

As regards the evolvement under the baseline scenario, a small increase in the provisioning 
ratio  of  5%  (compared  to  current  levels)  is  applied  to  reflect  the  introduction  of  IFRS  9 
rules, based on the results of the EBA Quantitative Impact Study (QIS) on the implementation of 
the new standard102. 

In order to accurately assess the inflow of new NPLs stemming from newly originated loans, data 
on historical loan originations and the corresponding default behaviour would be needed, which 
are  not  available  neither  to  the  EBA  nor  to  the  Commission.  In  view  of  this  and  other  data 
limitations  it  was  necessary  to  make  some  simplifying  assumption  with  regards  to  the 
available historic data; in particular, the quantitative analysis is based on the static balance 
sheet  assumption.103  Under  the  static  balance  sheet  assumption,  the  only  change  considered  in 
the analysis is the future inflow of newly originated NPEs. As such, no changes are assumed in 
the  outstanding  stock  of  exposures  (defaulted  and  non-defaulted)  and  in  the  newly  originated 
non-defaulted exposures. The same holds for other balance sheet items, such as for instance the 
CET1  and  Tier  2  capital.104  The  only  change  considered  in  the  analysis  is  the  future  inflow  of 
newly originated NPEs. As such, no changes are assumed in the outstanding stock of exposures 
(performing  and  non-performing)  and  in  the  newly  originated  performing  exposures.  The  same 
holds for other balance sheet items, such as for instance the regulatory capital. In addition, it is 
assumed that there will be no changes in some key ratios observed at the institution level. It is 
assumed  that  the  shares  of  secured  versus  unsecured  exposures  that  is  observed  historically 
remains constant in the future, that there is no improvement in cure rates (CRs)105 in spite of the 
recent  introduction  of  qualitative  NPL  guidance,  that  there  is  no  change  in  the  provision  and 
write-off  coverage,  that  default  rates  remain  constant,  i.e.  it  is  assumed  that  there  is  no 
improvement in the origination standards. 

The  results  of  the  quantitative  analysis  would  appear  to  present  an  upper  bound  to  the 
estimated effects because of two main reasons. First, the methodology makes use of historical 
data which have been collected at time periods where generally high levels of NPEs have been 
observed (resulting in high projected inflows of NPEs), when generally profitability was very low 
and where provisioning levels were below today’s levels, and extrapolates these inputs to a 20-
year horizon. Second, the analysis excludes any kind of dynamic effects but makes the historical 
parameters static albeit they are likely to change given the economic recovery and banks actions 
in response to the backstop and possible supervisory measures. In particular, it is expected that 
banks take actions to change loan origination standards and improve NPE management (such as 
work-out, restructuring or disposal of NPEs) as a result of the prudential backstop measure, such 
that the actual impact will definitely be lower. Such behavioural changes however are not taken 
into account in the quantitative analysis. 

101 Domestic banking groups and stand alone banks, foreign (EU and non-EU) controlled subsidiaries and foreign (EU 
and non-EU) controlled branches, All institutions, Risk weighted exposure amounts for credit risk (Link to the general 
SDW, consolidate banking data: http://sdw.ecb.europa.eu/browse.do?node=9689685). 
102 The results of the EBA IFRS QIS exercise are available at: https://www.eba.europa.eu/-/eba-updates-on-the-impact-
of-ifrs-9-on-banks-across-the-eu-and-highlights-current-implementation-issues. 
103 For more details on the data sources used for the quantitive analysis see EBA (2018) "Report on statutory prudential 
backstops". 
104 In its response to the Commission’s call for advice, the EBA further elaborates on these assumptions and explains 
which sensitivity analysis it has conducted in order to address related uncertainties. 
105 CR is the percentage of loans that previously presented arrears and, post restructuring, present no arrears. 

42 

 
                                                            
6.2.  Option 1: Statutory backstop with end-of-period coverage requirement 

6.2.1.  Benefits 

Option  1  would  help  constraining  the  ability  for  banks  to  delay  the  provisioning  of  NPEs  in 
comparison  with  the  baseline,  as  banks  would  have  a  time  limit  after  which  they  will  have  to 
ensure for a full coverage of their NPEs. 

As it would imply only a simple deduction at the end of a defined time period without looking at 
the collateral value, Option 1 would be the least complex option. For banks currently subject to 
Pillar 2 measures, it would be even less complex than the baseline as they are already facing costs 
related to the implementation of Pillar 2 measures imposed by their supervisors.  

6.2.2.  Costs 

Option 1 would give fewer incentives to banks not to delay loss recognition for secured NPLs in 
the short term in comparison with the other options, as the coverage requirements would apply 
only  after  a  perennial  period  of  time.  This  would  also  hold  true  for  unsecured  NPEs  in 
comparison with Option 2 (gradual coverage requirement) as the potential deduction would only 
be triggered after two years. 

More importantly, as the  full coverage requirement  would  apply only at the end of the defined 
time  period,  Option  1  would  potentially  lead  to  considerable  cliff-effects.  Banks  which  do  not 
meet the minimum coverage requirement could then face abrupt increases in deductions after 2 
years for unsecured NPEs and after 6 to 8 years for secured NPEs.  

EBA estimates indicate that this option would lead to an average reduction in EU banks’ CET1 
capital  ratio  of  equal  to  197  to  213  bps  on  cumulative  basis  over  20  years,  depending  on  the 
period after which full coverage is required (6 to 8 years for secured NPEs). Figure 16 shows the 
cumulative impact on CET1 capital ratio in bps (Y-axis) over the years after the implementation 
of the backstop measure (X-axis).106 There is zero effect on capital ratio before year 2 (𝑡2) since 
the backstop is not binding. In year 3 (4 and so on) the backstop starts biting the new unsecured 
NPEs  that  have  been  originated  in  year  0  (1  and  so  on)  and  in  year  7  (8  and  so  on)  also  the 
secured NPEs that have been originated in year 0 (1 and so on). 

Option 1 would induce a moderate increase of administrative costs compared to the baseline, as 
all  banks  would  have  to  implement  a  common  prudential  backstop.  This  holds  also  for  banks 
which would actually not be affected by an effective deduction because they would still have to 
implement the framework to monitor their coverage level. The accelerated capital needs induced 
by the prudential backstop might be compensated by a decrease in Pillar 2 requirements, for those 
banks which were subject to dedicated Pillar 2 measures in this regard. 

106 Note that the subscripts 𝑡1, 𝑡2, 𝑡3 in the x axis of Figure 16 refer to a future point in time, respectively 1 year, 2 years 
and 3 years after implementation of the new backstop legislation. There is zero effect on capital ratio before year 2 (𝑡2) 
since the backstop is not binding. In year 3 (4 and so on) the backstop starts biting the new unsecured NPEs that have 
been originated in year 0 (1 and so on) and in year 7 (8 and so on) also the secured NPEs that have been originated in 
year 0 (1 and so on). 

43 

 
 
 
 
                                                            
 
Figure 16: backstop with end-of-period coverage requirement (cumulative impact, weighted average) 

s
i
s
a
b
n

i

o
i
t
a
r

l

a
t
i
p
a
c
1
T
E
C
a
t
l
e
d
e
v
i
t
a
u
m
u
c

l

s
t
n
o
p

i

0

-50

-100

-150

-200

-250

100% after 6years

100% after 7 years

100% after 8 years

t₁  t₂  t₃  t₄  t₅  t₆  t₇  t₈  t₉ t₁₀ t₁₁ t₁₂ t₁₃ t₁₄ t₁₅ t₁₆ t₁₇ t₁₈ t₁₉ t₂₀ 

years after the implementation of the backstop measure 

Source: EBA (2018) 

6.2.3.  Impact on key stakeholders 

The  impact  on  the  key  stakeholders  (corporates  including  SMEs  and  retail,  banks,  public 
authorities)  is  assessed  against  the  baseline  scenario.  The  three  policy  options  present  common 
features and might to a certain extent have similar effects. Some impacts are however specific to 
the relevant option.  

Table 4:  Positive and negative impacts, stakeholder type – Option 1 

Impact on key 
stakeholders 

Corporate (including SME) 
and retail customers as 
borrowers  

Banks 

Member States and supervisors 

Positive 

+ (more stable provision of credit 
to corporates)  

 + (limited provisioning needs in 
the short run, increased resilience 
in the long run) 

+ (strengthened financial 
stability, higher growth) 

Negative 

≈ 

- - (end of period cliff effect, 
smaller long term effect on banks 
resilience) 

- (deductions would not trigger 
before several years) 

Notes: ++ = strongly positive; + = positive; - = negative; -- = strongly negative; ≈ = neutral/marginal. 

  Corporate (including SME) and retail customers as borrowers: 

By strengthening banking banks' balance sheets with a more timely and effective management of 
NPEs,  this  option  would  support  a  more  stable  supply  of  credit  (see  section  6.6).  The  positive 
impact  should  be  particularly  to  the  benefit  of  SMEs,  since  these  are  more  dependent  on  bank 
lending than large corporates which might access more easily financial markets. Freeing lending 
capacity of banks will therefore have a direct positive impact on SMEs funding. 

  Banks 

For  what  concerns  their  secured  NPEs,  no  changes  would  occur  for  banks  with  respect  to  the 
status quo in the short run. There would be little incentives (in comparison with the baseline as 

44 

 
 
 
  
 
 
 
 
 
 
 
 
well as the other options) to increase their loss coverage particularly for secured NPEs in a timely 
manner. Early movers (i.e. those banks building up coverage voluntary before [full] coverage is 
statutorily required at the end of the period) could indeed be put at a disadvantage with respect to 
late  movers  since  they  would  adjust  their  own  funds  and/or  recognise  losses  impacting  their 
CET1 ratios and/or profits earlier than late movers. On the other hand, a cliff-effect at the end of 
the coverage period might have a severe impact on the late movers, as the required coverage level 
would  abruptly  jump  from  0%  to  100%  after  the  defined  time  period.  For  what  concerns 
unsecured NPEs, the minimum requirement (full deduction after 2 years) would decrease banks' 
profitability in the short run. 

In  the  long  run,  the  impacts  on  all  banks  would  be  beneficial  because,  by  avoiding  that  under-
provisioned NPEs reach unsustainable levels, the backstop would help strengthen their resilience 
to  economic  crisis,  lowering  their  funding  and  administrative  costs  and  protecting  their 
profitability. The prudential backstop would indeed not increase capital requirements for NPEs, 
but  only  alter  the  distribution  of  capital  needs  to  cover  losses  on  NPEs  over  time  (without 
increasing their overall size). 

As regards bank profitability, for institutions with sound provisioning practices already in place, 
i.e.  where  existing  provisions  exceed  the  levels  required  by  the  backstop,  no  impact  will  be 
observed.  In  the  cases,  where  the  backstop  does  lead  to  increased  coverage  (via  prudential 
deductions from own funds or increases in accounting provisions), the impact on profitability will 
depend on a wide range of factors, most notably the requirements of the accounting framework, 
tax regimes, mitigating effects deriving from any proceeds from sales (which depend on the sale 
price), as well as other firm-specific circumstances.107 

  Member States and supervisors 

Tackling the issue of under-provisioning of NPEs would reduce financial stability risks and foster 
a more stable supply of credit to firms and households. In the short term, requiring minimum loss 
coverage  for  NPEs  would  reduce  the  risk  of  banks'  failures  and  resulting  spill-overs  across 
jurisdiction,  and  therefore  strengthen  the  stability  of  the  EU  banking  sector  as  a  whole.  In  the 
longer  run,  reducing  the  net  NPL  ratio  of  EU  banks  will  support  economic  growth.  These 
beneficial  effects  are  however  mitigated  by  the  design  of  Option  1  where  the  backstop  only 
applies after the defined time period has elapsed.   

Under Option 1 full coverage of secured NPEs would only be triggered at the end of the defined 
time  period  (6  to  8  years).  Banks  having  insufficient  coverage  for  their  NPEs  might  therefore 
change their behaviour only to a small extent during the first years of this period. Consequently, 
supervisors might need to strengthen their Pillar 2 reviews for a large population of banks, aiming 
at  ensuring  sufficient  loss  coverage  at  any  point  in  time  and  mitigating  the  cliff  effects  of  a 
harmonised Pillar 1 backstop kicking in abruptly. 

6.1.4 Stakeholders' feedback during the targeted consultation  

A  number  of  banks  and  most  public  authorities  expressed  support  for  the  introduction  of  a 
statutory  backstop  to  harmonise  NPEs  provisioning.  Most  answers  stressed  however  the 
disadvantages  of  having  an  end-of-period  deduction,  as  this  would  lead  to  major  cliff-edge 
effects. In fact, most banks and public authorities stated option 1 (end-of-period deduction, both 
for secured and unsecured NPEs) as their least preferred. Banks supporting the introduction of a 
prudential backstop showed a preference for a design entailing a gradual deduction (i.e. option 2). 

Some  banks  argued  more  generally  that  the  existing  Pillar  2  powers  of  competent  authorities 
should be enough to tackle the issue of under-provisioned NPEs.  

107 Cf. EBA (2018). 

45 

 
                                                            
6.3.  Option 2: Statutory backstop with gradually increasing coverage requirement 

6.3.1.  Benefits 

In  terms  of  effectiveness  to  meet  the  specific  objectives,  this  option  would  require  banks 
ultimately  to  fully  cover  their  NPEs  after  a  certain  period  of  time,  therefore  strongly  reducing 
their  ability  to  "wait  and  see"  (first  specific  objective  laid  down  in  section  4.2).  The  objective 
would be quickly met, as the minimum coverage would by design kick in as soon as the exposure 
becomes non-performing. At the same time institutions would have strong incentives to provision 
NPEs at an early stage (second specific objective laid down in section 4.2) since they would not 
have the possibility to wait until the end of the period to increase their provisioning. Therefore, 
the main benefit of this option is the avoidance of too abrupt and potentially harmful impact at 
the end of the defined time period.  

Option 2 would also be consistent and coherent with other EU policies. Supervisors could focus 
their work on outlier banks also during the first years as compared to option 1. This would help 
ensure efficient use of resources and support EU-wide harmonisation in addressing NPEs. 

By  choosing  a  progressive  path,  the  design  of  the  backstop  would  be  aligned  with  another 
envisaged  initiative  of  the  Commission  which  is  the  acceleration  of  extra-judicial  collateral 
enforcement.  It  would  require  less  coverage  during  the  first  years  when  the  collateral  is  more 
likely to be realised. 

6.3.2.  Costs  

Option 2 would induce higher costs in terms of capital needs and implementation costs compared 
to  the  baseline  for  banks  not  currently  subject  to  any  Pillar  2  measures  increasing  their  NPEs 
provisioning.  Additional  costs  would  also  exist  for  banks  subject  to  Pillar  2  measures  in  case 
these measures are insufficient to fully address the under-provisioning of NPEs. 

Option  2  would  potentially  be  costlier  at  an  earlier  stage  than  Options  1  and  3  as  the  potential 
deduction  would  trigger  immediately  the  first  year  following  the  classification  as  NPE,  and 
would be less risk-sensitive than under Option 3. However,  choosing  a progressive path would 
help  to  alleviate  this  concern  as  the  amount  to  be  covered  would  be  lower  in  the  first  years, 
giving banks time to proactively address the NPEs (including through forbearance measures). 

EBA  estimates  indicate  that  the  option  with  a  linear  coverage  path  would  lead  to  an  average 
reduction in EU banks’ CET1 capital ratio of equal to 231 to 239 bps on cumulative basis over 20 
years,  depending  on  the  period  after  which  full  coverage  is  required  (6/7/8  years  for  secured 
NPEs; see Figure 17). 

46 

 
 
 
 
 
 
 
 
 
 
Figure 17: backstop with linearly increasing coverage requirement (cumulative impact, weighted average) 

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years after the implementation of the backstop measure 

Source: EBA (2018) 

However,  applying  a  progressive  coverage  path  under  this  option  would  slightly  lower  the 
average impacts and lead to an average reduction in EU banks’ CET1 capital ratio of equal to 217 
to 227 bps on cumulative basis over 20 years, depending on the period after which full coverage 
is required (6/7/8 years for secured NPEs; see Figure 18). 

Figure 18: backstop with progressively increasing coverage requirement (cumulative impact, weighted average) 

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years after the implementation of the backstop measure 

Source: EBA (2018) 

47 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
6.3.3.  Impact on key stakeholders 

Table 5:  Positive and negative impacts, stakeholder type – Option 2 

Impact on key 
stakeholders 

Corporate (including SME) 
and retail customers as 
borrowers  

Banks 

Member States and supervisors 

Positive 

++ (more stable provision of 
credit to corporates )  

++ (strong increase in bank 
resilience in the long term) 

++ (strengthened financial 
stability, higher growth) 

Negative 

≈  

- (higher capital needs in the 
short-run) 

≈ (slight increase of human and 
financial resources) 

Notes: ++ = strongly positive; + = positive; - = negative; -- = strongly negative; ≈ = neutral/marginal. 

 

 Corporate (including SME) and retail customers as borrowers: 

The  application  of  a  gradual  coverage  requirement  would  be  more  effective  than  option  1  in 
terms  of  providing  incentives  and  ability  to  overcome  bank's  "wait  and  see"  practises  at  early 
stages of a defaulted credit. In this way the option reduces financial stability risks associated with 
NPLs  and  supports  a  more  stable  supply  of  credit  (see  section  6.4).  As  a  consequence  credit 
supply for large and smaller corporates would be strengthened, especially during stressed times. 
As  for  option  1,  the  positive  effects  on  total  credit  availability  should  be  particularly  to  the 
benefit  of  SMEs,  because  they  are  depending  to  a  greater  extent  on  bank  loans  than  large 
corporates. 

  Banks 

In the short run, the own funds of banks that do not meet the applicable minimum coverage level 
(and  that  would  therefore  be  subject  to  the  gradual  deduction)  would  decline  compared  to  the 
baseline.  However,  all  banks  would  be  measured  against  a  common  yardstick  at  each  point  in 
time which increases comparability and promotes a level-playing throughout the Single Market. 
Furthermore,  cliff-edge  effects  at  the  end  of  the  deduction  period  would  not  take  place,  thus 
avoiding potentially severe impacts on banks' capital further down. 

In  the  long  run,  the  impacts  on  banks  would  be  beneficial  because,  by  avoiding  that  under-
provisioned NPEs accumulate and reach unsustainable levels, the backstop would help strengthen 
their resilience to economic crisis, lowering their funding and administrative costs and protecting 
their  profitability.  The  prudential  backstop  would  indeed  not  increase  capital  requirements  for 
NPEs, but only alter the distribution of capital needs to cover losses on NPEs more evenly over 
time (without increasing their overall size). 

As regards the impact on bank profitability, the same considerations as set out for Option 1 (see 
section 6.2.3.) apply to Option 1. 

  Member States and supervisors 

By tackling the issue of under-provisioning of NPEs in the most effective way, this option would 
reduce financial stability risks and foster a more stable credit access for firms and households.  

Compared  to  Option  1  supervisors  could  focus  on  more  problematic  or  outlier  cases  because 
minimum  coverage  levels  would  be  required  from  the  first  year  after  the  classification  of  an 
exposure  as  non-performing.  This  would  allow  for a  more  targeted  use  of  human  and  financial 
resources, thereby increasing the efficiency of the framework. 

48 

 
 
 
6.3.4.  Stakeholders' feedback during the targeted consultation  

Public  authorities  and  banks  preferred  a  gradual  coverage  path  over  and  end-of-period  one, 
mostly for fear of cliff-edge effects in the latter design. Among gradual deduction designs, banks 
showed  some  reluctance  in  respect  to  a  linear  path  of  full  coverage  requirement,  because  this 
approach would be overly conservative in the first years, where the chances to recover the loan or 
the  collateral  are  higher  than  towards  the  end  of  the  period.  Consequently,  they  preferred  a 
progressive  path  of  full  coverage  requirement  which  would  to  a  greater  extent  recognise  the 
current  practices  in  terms  of  loan  recovery  and  collateral  realisation.  This  was  also  the  view 
expressed  by  most  public  authorities.  Some  stakeholders  argued  in  favour of  full  discretion  for 
banks to decide on the path within the defined time period. 

6.4.  Option 3: Statutory backstop with haircuts 

6.4.1.  Benefits 

Option  3  would  present  the  same  benefits  as  Option  2  in  terms  of  effectiveness  as  regard  to 
reducing the ability and the incentives for banks to delay NPEs provisioning, as it would require 
a minimum coverage requirement in the first years after the classification as non-performing.  

However,  the  haircut  approach  would  be  more  risk-sensitive  because  it  would  distinguish 
between different types of credit protection. As it would be more granular, it would capture more 
specifically  valuation  uncertainties  and  possible  falls  in  value  up  to  the  realisation  of  the 
collateral/guarantee. 
to 
exercise/sell/liquidate the credit protection. In that regards, it can be assessed as highly coherent 
with  the  general  principles  of  the  EU  credit  risk  rules,  which  generally  follow  a  risk-based 
approach. 

It  would  also  better  capture  maintenance  costs  and  costs 

6.4.2.  Costs 

As  the  other  options,  this  option  3  would  likely  induce  accelerated  capital  needs  compared  the 
baseline for banks which do not have sufficient loss coverage for their NPEs and which are not 
subject to dedicated Pillar 2 measures. As Option 2, these capital needs would kick in earlier than 
under Option 1.  

This option would require banks to implement specific methodologies to apply adequate haircuts 
depending on the type of credit protection (collateral/guarantee). Compared to the baseline, this 
would likely imply material implementation costs. 

Option 3 would require thorough and lengthy work from the EBA and CAs to list the different 
types of credit protection and determine the haircuts which could be applied to them. 

Besides,  a  backstop  focusing  on  the  type  of  credit  protection  might  send  the  wrong  signal  to 
institutions, as they could be incentivized to base their decision to grant loans depending on the 
regulatory  treatment  of  the  credit  protection  rather  than  the  ability  of  debtors  to  generate  cash-
flows in the future to reimburse the loan. This tendency observed before and during the crisis is 
precisely one of the reasons which led to the build-up of NPEs and should be avoided.  

Option 3 is therefore poorly efficient in terms of cost to reach the specific objectives set out in 
section 4.2. 

EBA estimates indicate that this option would lead to an average reduction in EU banks’ CET1 
capital ratio of equal to 248 to 262 bps on cumulative basis over 20 years, depending on (i) the 
period after which full coverage is required (6/7/8 years for secured NPEs) and (ii) the level of 
initial  haircut  applied  to  the  credit  protection  (20%/30%/40%)  as  well  as  on  (iii)  the  approach 
applied  to the unsecured part  of NPEs (end-of-period/linear/progressive path).  Figure 18 shows 

49 

 
minimal  differences  in  the  cumulative  (annual)  capital  impact  between  the  end-of-period  (here 
referred to as 'baseline'), linear and progressive path under the haircut approach where the impact 
is around 252 to 259 bps for the three approaches. 

Figure 18: backstop with haircut approach (100% coverage after 7 years, cumulative impact, weighted average) 

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6.4.3.  Impact on key stakeholders 

Table 6:  Positive and negative impacts, stakeholder type – Option 3 

Impact on key 
stakeholders 

Corporate (including SME) 
and retail customers as 
borrowers  

Banks 

Member States and supervisors 

Positive 

++ (more stable provision of 
credit to corporates )  

++ (strong increase in bank 
resilience in the long term) 

++ (strengthened financial 
stability, higher growth) 

Negative 

- (focus on collateral only) 

- - (higher capital needs, 
complexity and IT/administrative 
costs causing lower profitability 
in the short term) 

- (sizeable increase in human and 
financial resources) 

Notes: ++ = strongly positive; + = positive; - = negative; -- = strongly negative; ≈ = neutral/marginal. 

  Corporate (including SME) and retail customers as borrowers: 

This  option  would  have  the  same  beneficial  effect  on  credit  provision  stability  as  option  2. 
However,  as  a  drawback,  option  3  might  also  encourage  banks  to  base  their  decision-making 
when  granting  loans  depending  on  the  collateral  value  rather  than  the  actual  ability  of  the 
customer to pay back his loan in the future. This might undermine the objective of reducing the 
build-up of NPEs.  

50 

 
 
 
  
 
 
 
 
 
 
 
 
 
 
  Banks 

As  for  option  2,  option  3  could  affect  banks  capital  levels  in  the  short  run  compared  to  the 
baseline, as their own funds would decrease as soon as the loan is classified as non-performing, 
for those which are subject to the deduction. For banks which already have sufficient coverage, 
no  impact  on  profitability  would  occur.  The  additional  complexity  of  option  3  with  respect  to 
option 2 would render the former costlier for banks in terms of operationalisation burden as they 
would  face  higher  implementation  and  IT  costs.  From  an  administrative  costs  perspective  it 
would require higher human and financial resources to adequately monitor and manage the credit 
protection of NPEs. 

The  same  positive  effects  on  long  term  bank  profitability  and  resilience  expected  for  Option  2 
would also be expected to materialise in Option 3. 

  Member States and supervisors 

Option  3  would  be  effective  in  a  way  similar  to  Option  2  in  tackling  the  issue  of  under-
provisioning  of  NPEs.  However,  it  would  be  considerably  more  complex  to  implement  and 
supervise.  Hence,  the  beneficial  effects  in  terms  of  financial  stability  risk  reduction  and  credit 
provision would be reduced by the increase in human and financial resources supervisors would 
need to deploy to oversee the more complex system introduced under this option.  

6.4.4.  Stakeholders' feedback during the targeted consultation  

Few  banks  have  showed  a  preference  for  the  more  risk-sensitive  and  granular  framework  of 
Option 3, based on a valuation of the NPEs credit protection. The majority of banks did not find 
any added value in the approach based on haircuts, arguing that the complexity and the additional 
implementation  costs  would  outweigh  the  small  benefits  they  would  get  in  terms  of  more  risk-
sensitive  deductions.  They  also  did  not  fully  understand  the  interaction  with  the  regulatory 
haircuts  already  applied  in  the  credit  risk  framework.  Public  authorities  did  not  express  an 
interest for an approach based on haircuts. 

6.5.  Taking into account profitability (quantitative analysis) 

According  to  EBA  estimates,  on  average  the  negative  impact  of  the  additional  coverage  on 
banks’ CET1 ratio can partly be offset by the profits generated by institutions and after dividends 
are  paid  out.  Assuming  that  institutions  use  the  respective  profits  remaining  after  paying  out 
dividends  for  additional  coverage,  the  cumulative  impact  on  CET1  over  the  20  year  projection 
horizon is reduced by around two thirds (e.g. from 205 bps basis points to less than 50 bps, if the 
end-of-period  coverage  approach  with  a  100%  coverage  after  7  years  is  used  as  baseline,  see 
Figure 19).108 

108 Note that the impact of the end-of-period coverage approach presented in this section differs slightly from the 
impact in the main analysis, because 10 institutions without the required supervisory reporting were dropped from the 
sample, reducing the sample to 117 institutions. To ensure comparability the impact is presented for the reduced 
sample. 

51 

 
 
 
 
 
                                                            
Figure  19:  Impact  of  accelerated  coverage  (end-of-period  coverage  approach =  baseline)  on  CET1  with  and  without 
considering profits 

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Source: EBA (2018) 

6.6. 

Statutory  prudential  backstop  under  an  adverse  economic  situation 
(crisis) 

In the case of severe impairment of EU financial markets GDP growth would sharply decelerate, 
unemployment rise and therefore default rates on outstanding loans would increase substantially. 
NPLs  will  therefore  rise.  The  key  question  to  understand  the  interactions  between  a  statutory 
backstop, capital requirements and credit procyclicality is how quick the increase in NPLs would 
be. History suggests that this increase is slow but persistent: the EA NPLs ratio reached its peak 
four years after it had increased first at the onset of the crisis.  

Without  a  minimum  backstop  banks  would  exert  discretion  in  their  NPLs  policy,  some 
institutions  would  act  pre-emptively  while  others  would  not  act  until  the  level  of  NPLs  is 
jeopardising their viability, attracting investors' attention and pushing their funding costs up. The 
pervasiveness of pro-cyclical provisioning is well documented across banks and  jurisdictions109 
and  leads  to  situations  where  banks  with  under-provisioned  NPLs  are  forced  to  raise  capital 
precisely  when  risk  aversion  is  at  its  highest  and  thus  markets  are  the  least  willing  to  provide 
capital.  This  forces  them  to  sharply  reduce  credit  provision  in  order  to  save  the  scarce  capital 
available,  which  adds  to  the  credit  tightening  that  is  naturally  triggered  by  an  economic 
downturn.  Pro-cyclical  provisioning  thus  translates  into  pro-cyclical  credit  provision  and  wider 
swings  in  the  economic  cycle  (from  boom  to  bust).  In  most  severe  cases,  under-provisioned 
banks become insolvent or illiquid, thereby threatening the stability of the wider banking system 
in a typical contagion fashion, with further pro-cyclical effects. 

Introducing  a  statutory  backstop  would  ensure  a  minimum  level  of  provisioning  applied  to  all 
banks.  This  would  imply  that:  a)  all  NPLs  generated  before  the  onset  of  the  crisis  have  a 
minimum coverage and thus institutions enter the crisis with more cushion and less legacy risk, 

109 See BCBS (2015) as well as Bikker and Metzemakers (2005). 

52 

 
 
                                                            
 
 
 
 
 
 
 
 
b)  NPLs  generated  after  the  onset  of  the  crisis  start  to  be  covered  before  their  level  reach  the 
point  in  which  the  bank's  viability  is  put  into  question  and  its  funding  costs  shoot  up.  Both 
implications  would  be  counter-cyclical,  they  would  reduce  the  procyclicality  of  provisioning, 
credit supply and thus growth. 

53 

 
 
 
7.  HOW DO THE OPTIONS COMPARE? 

The  quantitative  analysis  of  the  potential  impact  on  bank  capital  shows  that  the  statutory 
prudential backstop would lead to an average decrease in the CET1 ratio of 197 to 262 bps after 
20 years whereby the cumulative impact is highest for the haircut approach (ranging from 248 to 
262  bps)  and  lowest  for  the  end-of-period  deduction  approach  (ranging  from  197  to  213  bps) 
followed  by  the  progressive  deduction  approach  (ranging  from  217  to  227  bps)  and  the  linear 
deduction approach (ranging from 231 to 239 bps). It needs to be stressed, though, that the results 
of  the  quantitative  analysis  present  an  upper  bound  to  the  estimated  effects  because  of  the 
conservative input variables and the static balance sheet assumption.110 Furthermore, these results 
include  –  and,  to  a  significant  extent,  seem  to  be  driven  by  –  outliers,  as  the  comparison  with 
median values suggests.111  

Table 7 compares the baseline to the three policy options in terms of effectiveness in meeting the 
specific  objectives  laid  down  in  section  4,  the  cost  efficiency  to  reach  these  objectives  and 
consistency with other EU policies. The scores are attributed to each option in comparison to the 
baseline on the basis of the analysis provided in section 6. 

Table 7: Summary of options in terms of effectiveness, efficiency and coherence 

Efficiency 

Coherence 

Score 

Effectiveness 

Objective 1  
To reduce 
the ability of 
banks to 
"wait and 
see"  

Objective 2   
To reduce the 
incentives for 
banks to "wait 
and see" 

Baseline  

Option 1 

Option 2 

0 

+ 

++ 

0 

≈/- 

++ 

0 

+ 

- 

0 

- 

++ 

0 

1 

5 

Option 3 
Magnitude of impact as compared with the baseline scenario: ++ strongly positive (score 2); + positive (score 1); – – 
strongly negative (score -2); – negative (score -1); ≈ marginal/neutral (score 0). 

++ 

++ 

- - 

+ 

3 

Table 7 shows that Options 2 and 3 are the most effective to meet the objectives set out in section 
4. Option 3 is however less performing in terms of cost efficiency than Option 2, which is itself 
less  performing  than  Option  1.  Option  2  is  the  most  consistent  with  other  EU  policies  in 
comparison with Options 2 and 3. In total, Option 2 scores the best.    

Table 8 also shows how the baseline and the options score in terms of stakeholder support and 
overall level of regulatory ambition. The latter could be an indication of the political challenges 
which could be triggered by the option. 

110 First, the methodology makes use of historical data which have been collected at time periods where generally high 
levels of NPEs have been observed (resulting in high projected inflows of NPEs), when generally profitability was very 
low and where provisioning levels were below today’s levels, and extrapolates these inputs to a 20-year horizon. 
Second, the analysis excludes any kind of dynamic effects but makes the historical parameters static albeit they are 
likely to change given the economic recovery and banks actions in response to the backstop and possible supervisory 
measures. In particular, it is expected that banks take actions to change loan origination standards and improve NPE 
management (such as work-out, restructuring or disposal of NPEs) as a result of the prudential backstop measure, such 
that the actual impact will definitely be lower. Such behavioural changes however are not taken into account in the 
quantitative analysis (cf. section 6.). 
111 The steady state median cumulative impact on the median EU bank’s CET1 capital ratio is around 132 bps for the 
end-of-period coverage approach, 152 bps for the coverage approach with linear path and 138 bps for the coverage 
approach with progressive path (when full coverage is required after 7 years). These figures are significantly lower 
than the average capital impact signalling the presence of outliers (cf. EBA [2018]). 

54 

 
 
 
 
 
 
 
                                                            
Table 8: Summary of pros/cons of options in terms of support and ambition  

Option  Effectiveness/efficiency/coherence  Private 

Baseline  Low 

1 

2 

3 

Low (1) 

High (5) 

Low (1) 

Supervisors' 
support 

Level of 
ambition/challenge  

Low 

Low 

Medium 

Medium 

stakeholders 
support 

High 

Low 

Low 

High 

Medium 

Low 

High 

High 

Table  8  shows  that  Option  2  present  the  best  combination  of  the  criteria  of  effectiveness, 
efficiency  and  coherence  underlined  by  its  high  score.  At  the  same  time,  public  authorities' 
support  is  high  for  this  option,  while  it  is  medium  for  Option  1  and  low  for  Option  3  or  the 
baseline. Private stakeholders such as banks showed little support for Options 1, 2 and 3, as they 
would prefer to retain the current state of play. Options 2 and 3 are rated to be more ambitious. 

55 

 
 
 
 
8.  PREFERRED OPTION 

In  light  of  the  above  assessment  of  the  different  policy  options,  the  most  adequate  measure  to 
ensure adequate levels of credit risk provisioning of NPEs is option 2: statutory backstop with 
a progressively increasing coverage requirement. It is the most effective option in achieving 
the objectives set in section 4. The build-up of the required minimum coverage level is smoother; 
it starts earlier and progressively increases without cliff-edge effects. EBA estimates112 indicate 
that this option would imply manageable impacts on EU banks’ CET1 ratio. This option is also 
preferred  by  all  public  stakeholders  who  responded  to  the  public  consultation  except  one.  It  is 
also the option preferred by the vast majority of private stakeholders who responded to the public 
consultation. 

8.1 REFIT (simplification and improved efficiency) 

This  initiative  introduces  a  new  tool  (minimum  coverage  requirements  for  incurred/expected 
losses  on  NPEs)  which  is  not  simplifying  existing  legislation.  However,  it  is  improving  its 
efficiency by ensuring a standardised minimum level of the existing provisioning rules across the 
Union.  Insofar  as  this  efficiency  leads  to  lower  levels  on  NPLs,  the  additional  efficiency  is 
estimated in Annex 3. It should however be pointed out that other current and past initiatives in 
the NPLs areas will also impact on NPLs levels, rendering hard a precise disentanglement of the 
efficiency gains delivered by each measure separately (see Annex 3 for details). 

112 Cf. EBA (2018). 

56 

 
 
 
 
                                                            
9.  HOW WILL ACTUAL IMPACTS BE MONITORED AND EVALUATED? 

6 to 8 years (depending on the final calibration of the period after which full coverage of NPLs 
would be required) after the date of application of this initiative, the Commission shall carry out 
an  evaluation.  The  objective  of  the  evaluation  will  be  to  assess,  among  other  things,  how 
effective and efficient the measure has been in terms of achieving the objectives presented in this 
impact assessment and to decide whether new measures or amendments are needed. 

The Commission services would monitor the effects of the retained policy option on the basis of 
the following non-exhaustive list of indicators: 

-  NPL/NPE  ratio  (amount  of  NPLs/NPEs  as  %  of  total  banking  sector  assets,  amount  of 
NPLs/NPEs as % of GDP) 

Controlling for NPLs drivers such as GDP growth, unemployment, policy rates, we would expect 
a decline in NPLs held in the banking sector following the introduction of statutory backstops. 

- Ratio of NPLs/NPEs covered by provisions and other adjustments 

Coverage for NPLs/NPEs should increase as banks are required to meet certain minimum levels. 

-  Cyclicality  of  credit  to  non-financial  corporations  and  households  (i.e.  correlation  between 
GDP growth and growth of credit to non-financial corporations and households) 

As  discussed  in  the  problem  definition  section,  high  levels  of  insufficiently  covered  NPEs 
increase  the  procyclicality  of  credit.  The  introduction  of  statutory  backstop  should  therefore 
reduce credit procyclicality. 

- Cyclicality of the price of credit to non-financial corporations and households (i.e. correlation 
between  GDP  growth and  interest  rates  paid  by  non-financial  corporations and  households  on 
credit provided) 

High levels of insufficiently covered NPEs also increase the procyclicality of the cost credit (i.e. 
of  interest  rates).  The  introduction  of  minimum  coverage  requirements  should  therefore  reduce 
credit costs' procyclicality. 

- NPL/NPE ratio and coverage ratio country by country 

The  lack  of  a  minimum  standard  for  NPLs  recognition  and  loss  coverage  has  caused,  together 
with other factors, different levels of NPLs in different EU jurisdiction. The introduction of such 
a standard should thus contribute to reduce the variation of both NPL and coverage levels across 
MSs (ceteris paribus). 

57 

 
 
 
 
ANNEX 1: Procedural information 

1.  LEAD DG, DECIDE PLANNING/CWP REFERENCES 

This  Impact  Assessment  Report  was  prepared  by  Directorate  D  "Regulation  and  prudential 
supervision of financial Institutions" of the Directorate-General for Financial Stability, Financial 
Services and Capital Markets Union" (DG FISMA). 

The  Decide  Planning  reference  of  the  "Statutory  prudential  backstops  addressing  insufficient 
provisioning for newly originated loans that turn non-performing is PLAN/2017/1991, published 
9 November 2017. 

Ensuring  sufficient  level  of  provisioning  for  losses  derived  from  NPLs  is  part  of  the  broader 
strategy  of  the  Commission  to  deal  with  NPLs.  This  possible  legislative  initiative  has  been 
announced in the Banking Union Communication (11.10.2017). 

2.  ORGANISATION AND TIMING 

Several services of the Commission with an interest in the assessment of the initiative have been 
associated in the development of this analysis. 

Three Inter-Service Steering Group (ISSG) meetings, consisting of representatives from various 
Directorates-General of the Commission, were held in 2017. 

The first meeting took place on 2 October 2017, attended by DG ECFIN, COMP, GROW, JUST, 
TRADE and the Secretariat General (SG).  

The second meeting was held on 8 November 2017. The representatives from DG ECFIN, JUST, 
GROW and the Secretariat General (SG) were present.  

The third meeting was held on 11 December 2017 and was attended by DG GROW and SG. This 
was the last meeting of the ISSG before the submission to the Regulatory Scrutiny Board on 6 
December 2017.  

The meetings were chaired by SG.  

DG FISMA has updated the Impact Assessment Report by taking into account the comments 
made by SG, ECFIN, JUST and GROW. In particular, the following changes were made 

  Subsidiarity: justification included that national/supervisory discretion is unfit to 

addressing the problem. 

  Baseline: explanation included on IFRS9, national discretion and Pillar 2 measures. 

  Assessment of policy options: a) possible short-term negative impacts of prudential 

backstops on corporate lending (incl. SMEs), b) clarification that impact of IFRS 9 is 
considered; and c) feedback from the targeted consultation presented more prominently. 

3.  CONSULTATION OF THE RSB 

The Impact Assessment report was examined by the Regulatory Scrutiny Board on 17 January 
2018. The Board gave a positive opinion (without reservations). 

4.  EVIDENCE, SOURCES AND QUALITY 

The impact assessment has been carried out with the comprehensive qualitative and quantitative 
evidence from: 

58 

 
  Targeted consultation carried out by the Commission in November 2017; 

 

Impact analysis by the EBA 

  Other sources used: ECB, ESRB, IMF, FSC, World Bank, Vienna Initiative for NPL 
reduction, EBRD, SSM report and other studies and papers referred to in the Text. 

59 

 
 
 
ANNEX 2: STAKEHOLDER CONSULTATION  

The Commission has consulted stakeholders in targeted ways. Below a list of the most important 
consultations:  

  Targeted public consultation during November 2017: 38 contributions received from 
private  stakeholders  (banks  and  interest  groups)  and  public  stakeholders  (supervisory 
authorities and MSs). 

  Meeting  with  representatives  of  Ministries  of  Finance  at  the  Council  Financial 

Services Committee on 6 November 2017 

  Bilateral  Meeting  with  stakeholders  (i.e.  bank  associations, 

industry,  SME 

representatives etc.) (on-going) 

  Banking  expert  group  meeting  on  25  September  and  14  December  2017  (a  closing 

meeting is scheduled for 26 February 2018) 

1.  TARGETED CONSULTATION 

1.1.  Context and coverage  

The Commission held a targeted consultation during November 2017 to assess the opportunity of 
introducing a prudential common backstop to tackle under-provisioning NPLs.  

The objective of the consultation was to collect views of private and public stakeholders on the 
feasibility of a prudential backstop, on its usefulness, on its possible design and on its possible 
unintended consequences. The questions covered all three policy options analysed in this impact 
assessment.  

The consultation was open to the public; most answers came from banks or banking associations, 
a  few  came  from  supervisors.  In  total, 38  answers  were  received:  29  from  private  stakeholders 
including one private individual, and 9 from public stakeholders. Geographical distribution of the 
replies is not balanced, as most replies came from Member States with the highest NPLs ratios. 

Figure 12: Geographical distribution of the respondents to the targeted consultation (38 in total) 

Austria

Czech Republic

France

Germany

Greece

Italy

Malta

Portugal

Spain

UK

EU associations

Other

1 

3 

1 

3 

8 

2 

1 

4 

4 

1 

1 

9 

60 

 
 
 
 
1.2.  Need for a prudential backstop 

  Banks or banking associations: 

A  few  respondents  from  the  private  sector  acknowledged  the  importance  of  a  harmonised  EU 
treatment.  They  pointed  out  the  fact  that  IFRS  9  leaves  too  high  discretion  to  set  loan  loss 
provisions, which would hamper the comparability between banks.   

Most  of  the  banks  or  banking  associations  which  answered  to  the  consultation  did  not  see  the 
benefits  of  introducing  a  prudential  common  backstop.  They  would  prefer  IFRS  9  to  be  fully 
implemented to assess afterwards if a prudential backstop is still needed. They also believe that 
Pillar 2 measures are sufficient to address on a case-by-case basis potential under-provisioning of 
NPEs.  

  Public authorities: 

All  public  respondents  except  two  insisted  on  the  relevance  and  usefulness  of  a  prudential 
backstop. Some pointed out that such backstop would adequately complement accounting rules, 
although the latter would remain the main tool to tackle under-provisioned NPEs.  

The two public stakeholders not in favour of a prudential backstop would prefer to leave time to 
IFRS 9 to be implemented before assessing again whether such backstop is needed.  

1.3. 

Feasibility of a prudential backstop  

  Banks or banking associations: 

A  few  banks  consider  feasible  a  prudential  common  backstop,  and  not  too  burdensome  to 
implement.  

Some banks showed reluctance for an automatic deduction which would not sufficiently take into 
account forbearance measures (as forborne loans can still fall under the non-performing category 
while the counterparty meets its requirements). They insisted on the need to distinguish between 
"going-concern"  loans  (i.e.  where  the  counterparty  is  able  to  meet  its  obligations  after  the 
application  of  forborne  measures)  and  "gone-concern"  ones  (i.e.  where  the  counterparty  is 
defaulted).  

Some  stakeholders  would  also  favour  recognising  value  to  the  collateral  even  after  the  time 
period of 6 to 8 years, for instance by waiving the applicable of the backstop in case the credit 
protection is still considered effective after assessment by an independent expert.  

Some respondents also disagree with the proposed time period for secured NPEs of 6 to 8 years, 
arguing  that  the  length  of  judicial  proceedings  differs  between  countries,  and  by  way  of 
consequence  that  the  proposed  time  periods  should  be  longer  to  ensure  all  cases  are  covered. 
Alternatively, different time periods could be applied depending on the type of NPEs.  

Other  options  were  proposed  by  some  banks,  such  as  strengthening  the  credit  risk  models  to 
require more conservative collateral valuation or higher credit risk haircuts.  

  Public authorities: 

Almost  all  public  stakeholders  considered  the  backstop  as  feasible,  pending  some  technical 
clarifications.  

Some public authorities recommended analysing the possibility of having longer periods than 2 
years for unsecured NPEs or 6 to 8 years for secured ones, based on a benchmark across Member 
States.  

Some respondents would also prefer recognising value to the credit protection of secured NPEs 
even after the defined time period has elapsed, and distinguishing between forborne loans where 

61 

 
 
the counterparty is able to meet its obligations and NPEs where the counterparty really defaulted. 
Some  also  advocated  excluding  from  the  scope  of  the  prudential  backstop  loans  where  the 
counterparty is only "unlikely to pay" but is still not in default.   

1.4.  Design of a prudential backstop 

a) Option 1 (end-of-period full coverage requirement) 

  Banks or banking associations: 

Some respondents preferred not to give any preference to the three proposed options, as they are 
against the introduction of any kind of backstop.  

Among  those  which  gave  preferences,  most  showed  reluctance  to  set  an  end-of-period  full 
coverage requirement which would lead to important cliff-effects. Banks would prefer to smooth 
the  impact  of  the  deduction  over  several  years.  Some  also  suggested  differentiating  between 
banks  specialised  in  managing  NPLs  and  the  others.  Those  whose  core  business  is  to  purchase 
and manage NPLs should be given a longer time period before full provisioning than traditional 
banks. 

  Public authorities: 

Supervisors and other public stakeholders did not express support for an end-of-period deduction 
option, as cliff-effects might be too high. 

b) Option 2 (gradual full coverage requirement) 

  Banks or banking associations: 

This option attracted the support of most respondents among those which expressed a preference 
between the three options. They favour in particular a progressive path of coverage requirement, 
as it would reflect more adequately the actual decrease in the proportion of NPLs (loans are more 
likely to be recovered in the first years after their classification as non-performing, i.e. it would 
be more justified to require lower coverage level at the beginning to give time to recover the loan 
or collateral in the first years).  

  Public authorities: 

Most of public stakeholders would favour a progressive approach rather than a linear one, as it 
would better recognise early recoveries of loans. One respondent favoured a linear approach for 
unsecured NPEs only, and another one would favour linear approach for both types of NPEs.  

For the same reason, one respondent suggested starting the gradual increase of the coverage level 
requirement  only  after  a  certain  number  of  years  after  classification  as  non-performing,  before 
reaching 100% at the end of the defined time period.  

Another  respondent  proposed  to  combine  Option  1  (end-of-period  requirement)  for  unsecured 
NPEs with Option 2 (progressive path) for secured NPEs. 

c) Option 3 (haircut approach) 

  Banks or banking associations: 

Two respondents from the banking sector supported an approach based on haircuts, as it would 
be more risk-sensitive.  

Other  banks  did  not  show  any  appetite  for  Option  3  as  it  would  lead  to  undue  complexity  and 
possible double-count with the haircuts already applied in the credit-risk framework.  

  Public authorities: 

62 

 
Most  of  public  stakeholders  did  not  favour  an  approach  based  on  haircuts,  which  would  be 
unduly complex and would require high amounts of resources to determine the appropriate levels 
of haircuts.  

Other  more  technical  questions  were  asked  to  the  public  on  the  methodology  for  collateral 
valuation, on its recoverability and on prudent valuations requirements for assets and off-balance 
sheet  items  valued  at  amortised  cost.  Most  of  the  respondents  either  agreed  with  the  proposed 
way forward (if any) or did not express any views. Some argued that collateral valuation should 
remain the main driver to assess the need of prudential coverage. Most of the stakeholders did not 
favour a common binding methodology for collateral valuation, although some public authorities 
and one private stakeholder did.  

1.5. 

Possible unintended consequences of a prudential backstop 

  Banks or banking associations: 

Some  banks  argued  that  a  prudential  backstop  would  induce  higher  mortgage  or  loans  pricing 
(through a higher LGD). It might also have an important impact on the volatility of their CET1 as 
non-performing  loans  might  perform  again  after  a  few  years  or  might  be  recovered  after  the 
defined time  periods (i.e.  after a full coverage will  already have been  imposed) in jurisdictions 
where judicial procedures are longer. According to them, this could have an impact on the overall 
financing of the real economy.   

Other  respondents  also  argued  that  imposing  a  time  limit  after  which  full  coverage  of  NPEs 
should be applied might incentivise banks to fire sale NPEs at very low prices. 

Another drawback of the introduction of a backstop according to some respondents would be that 
banks  are  incentivised  to  enforce  the  collateral  of  secured  loans  as  soon  as  the  counterparty 
defaults, potentially increasing its difficulties.  

  Public authorities: 

Most  of  the  supervisors  did  not  see  any  unintended  consequence  of  the  introduction  of  a 
prudential backstop.  

Some public authorities however pointed out the risk to decrease debtors' chances to recover in 
case banks enforce as quickly as possible the collateral of secured loans.  

Some also pointed out the risk to incentivise banks to grant secured loans rather than unsecured 
ones in order to benefit from a longer time period before the full coverage requirement kicks in. 

2.  EXPERT GROUP ON BANKING, PAYMENTS AND INSURANCE (EGBPI) MEETINGS 

An EGBPI meeting was organised on 25/09/17 to collect Member States views on the micro-
prudential aspects of the Commission envisaged work on NPLs. 

The Commission explained its intention to issue an interpretation of Art 16  SSMR and Art 104 
CRD  IV  and  to  introduce  a  dedicated  recital  giving  further  details  on  these  articles,  hence 
clarifying  that  EU  legislation  (already)  provides  supervisors  with  powers  to  address  risks 
stemming from NPLs, including the power to influence a bank's provisioning level and to require 
specific adjustments to own funds where necessary for prudential purposes. 

Moving  beyond  this  interpretation,  the  Commission  explained  to  Member  States  considering, 
within the framework of the  ongoing review of the  CRR/CRD IV, the introduction of statutory 
prudential  backstops  to  prevent  the  build-up  and  potential  under-provisioning  of  future  NPLs 
stocks  across  Member  States  and  banks.  The  Commission  mentioned  the  need  to  conduct  an 

63 

 
 
 
impact  assessment,  preceded  by  a  short  public  consultation;  on  the  basis  of  this  impact 
assessment, the Commission will decide on how to proceed. 

Regarding the clarification of existing supervisory powers, one Member State enquired about the 
exact mechanism that would be used to clarify existing powers. The Commission clarified that a 
recital is the most effective and time-efficient manner to do so. It is Commission's opinion that 
the powers are already present, so clarifying through a recital is the most suitable way forward. 
Responding to  a question from another Member State, the Commission explained that this also 
constitutes a public clarification, as it will also be part of the SSM Review report. This Member 
State  also  enquired  about  the  potential  consequences  of  extending  powers.  The  Commission 
made clear that there is no question of an extension of powers, only clarifying what already exists 
in  the  legislation.  A  third  Member  State  welcomed  Commission's  interpretation,  although 
conveyed its preference for Level 1 legislative text. The Commission emphasised that the recital 
in  fact  constitutes  Level  1.  As  regards  questions  about  the  timing  of  the  interpretation,  the 
Commission emphasised that it is not and cannot be late, as the legislation already exists. 

Concerning  the  potential  introduction  of  statutory  prudential  backstops,  a  Member  State  asked 
whether  the  process  would  entail  only  an  impact  assessment  or  would  also  involve  calibration. 
The  Commission  indicated  that  it  would  indeed  perform  the  necessary  calibration.  Another 
Member State suggested the need to take into account IFRS, but another one cautioned, however, 
that discussions about IFRS should not be reopened. A Member State stated that it would also be 
warranted  to  consider  the  stock  of  NPLs,  rather  than  only  future  flows.  The  Commission 
responded that the Action Plan only asked to look at new loans, so this will be the focus. Lastly, 
following  a  comment  from  a  Member  State  about  the  method,  the  Commission  explained  that, 
since  the  banking  package  has  nothing  on  credit  risk,  a  new  proposal  is  the  only  option  going 
forward.   

Another  EGBPI  meeting  took  place  on  14/12/17  on  all  Commission's  initiatives  on  NPLs 
being currently in the making. 

The Commission presented the consultation paper which was published in November 2017 on a 
possible prudential backstop to tackle insufficient provisioning of NPLs. At the same occasion, 
the SSM also presented their consultation document on an Addendum to the guidance on NPLs 
already  published  in  March  2017.  All  Member  States  welcomed  the  envisaged  initiative  of  the 
Commission  and  indicated  their  support  for  the  introduction  of  a  prudential  backstop.  Some 
Member States showed  support for a deduction  approach  following a progressive path. Several 
Member  States  insisted  on  the  need  to  introduce  it  quickly  in  the  legislation, to  use  the  benign 
economic  circumstances  and  bring  clarity  to  banks  and  other  stakeholders.  The  Commission 
recalled its intention to present a legislative proposal, if any, at the same time as the other NPLs 
initiatives  in  Spring  2018.  A  few  Member  States  recommended  distinguishing  between  loans 
which  are  "unlikely  to  pay"  or  "past  due"  and  those  which  are  defaulted.  In  their  views,  the 
former  could  be  subject  to  longer  time  period  before  full  coverage  than  the  latter.  The 
Commission (backed by the EBA and the ECB) recalled however the need to use a harmonised 
definition  of  NPLs,  as  already  used  by  the  EBA  for  supervisory  reporting  purposes.  This 
definition  includes  loans  which  are  "unlikely  to  pay".  One  Member  State  inquired  how  loans 
recovery  values  would  be  taken  into  account.  The  Commission  confirmed  that  any  deducted 
amount which would be recovered by the bank would be added back to its CET1. Other technical 
questions on the state of play (i.e. delay) of the answer to the Call for Advice were addressed by 
the EBA. 

64 

 
 
 
ANNEX 3: WHO IS AFFECTED AND HOW? 

2.1.  Practical implications of the initiative 

Under the retained option (option 2: statutory backstop with a gradual deduction) a harmonized 
minimum  requirement  for  gradual  provisioning  of  secured  and  unsecured  NPEs  will  be 
established  at  EU  level.  This  EU  framework  would  aim  at  a  minimum  level  of  harmonization 
across  the  EU,  building  on  the  characteristics  of  existing  national  jurisdictions  and  seeking  to 
avoid  disrupting  well-functioning  markets.  This  option  will  require  institutions  to  adjust  their 
NPEs  management  policies  to  implement  the  minimum  requirement  while  supervisors  should 
integrate this in their supervisory conduct. 

The  retained  option  is  supported  by  all  public  stakeholders  who  answered  to  the  public 
consultation.  It  also  obtained  the  highest  support  of  private  stakeholders  relative  to  the  other 
proposed options. 

2.2.  Summary of costs and benefits 

As  explained  in  the  main  text,  the  main  objective  of  this  initiative  is  to  foster  timelier  NPL 
provisioning so  as  to  reduce  NPL  build  up,  which  in  turn  has  various  negative effects  on  bank 
profitability,  financial  stability,  employment  and  economic  growth.  Several  studies  estimated 
these  effects.  We  use  them  to  provide  qualitative  estimates  of  the  costs  and  benefits  of  this 
initiative.  In  other  words,  we  provide  indications  on  the  main  macro-financial  magnitudes  that 
should be affected by this initiative and on their expected direction. 

We  refrain  from  quantitative  point  estimates  as  these  would  require  modelling  of  the  whole 
economy and would be based on data on effects of several measures taken to tackle NPLs issues. 
In practice, most countries that have faced the NPL problem have implemented various policies 
of NPL reduction together with the statutory backstop. For example, Spain also set up an AMC 
(named  SAREB)  where  NPLs  were  transferred  from  banks  and  dealt  with  in  an  organic  and 
coordinated way. Furthermore, some of the policies were applied to the entire stock of existing 
NPLs while the statutory backstop would be applied to newly originated loans only. Finally, this 
initiative (statutory backstops introduction) is twinned with the AECE and the secondary market 
development  initiatives,  whose  results  are  expected  to  be  mutually  reinforcing  (as  discussed  in 
section 6.5), and IFRS9 and Pillar 2 measures tackling NPLs were introduced recently. For these 
reasons, it is hard to disentangle the effect of this single initiative from the others in the package. 

The qualitative estimates of this initiative's benefits are presented in the table below.  

I. Overview of Benefits (total for all provisions) – Preferred Option 

Description 

Amount 

Direct benefits 

Comments 

Lower cost of funding for 
issuers  

Reduction of bank average funding cost 

More efficient banks 

Reduction of average interest margin charged to 
customer 

Stakeholders who benefit: 
a) issuers 
b) citizens (firms and households) 

Stakeholders who benefit: 
a) issuers 
b) citizens (firms and households) 

Lower due diligence costs 

Reduction of costs related to assessing a bank's 
coverage of problematic loans 

Stakeholders who benefit: 
a) investors 

Easier comparability of 
NPEs for supervisors 

Reduced discretion in NPLs reporting standards 

Stakeholders who benefit: 
a) institutions 

65 

 
 
Higher economic growth  

Increase of EU GDP growth  

Indirect benefits 

Lower unemployment 

Reduction in EU unemployment 

Lower risks of financial 
instability 

Removal of "pockets of risks" due to under 
provisioning in some part of EU financial 
markets/credit institutions – Lower contagion risk 

Higher credit provision 

Increase in credit growth 

More liquid secondary 
markets for NPEs 

Reduced uncertainty on NPL portfolios' fair 
value, narrower bid-ask spreads 

Stakeholders who benefit: 
a) issuers 
b) citizens (firms and households) 
c) institutions 

Stakeholders who benefit: 
a) citizens (firms and households) 

Stakeholders who benefit: 
a) issuers 
b) citizens (firms and households) 
c) institutions 

Stakeholders who benefit: 
a) issuers 
b) citizens (firms and households) 

Stakeholders who benefit: 
a) issuers 
b) investors 

Source: own estimations and Nkusu (2011); “Vienna Initiative” (2012); and ESRB (2017) 

II. Overview of costs – Preferred option 

Citizens/Consumers  

Businesses 

Administrations 

One-off 

Recurrent 

One-off 

Recurrent 

One-off 

Recurrent 

N/A 

N/A 

Direct costs 

Introducti
on of 
statutory 
backstop   

Indirect costs 

Stronger 
provisioning 
requirement
s may 
reduce 
lending 
available to 
some 
segments in 
the short run 

N/A 

Adjustment 
to new 
supervision 
rules 

Accelerated 
provisions 
required by the 
statutory 
prudential 
backstops 
(EBA 
estimates): 
cumulative 
average impact 
on CET1 ratio 
between 197 
and 262 bps 
after 20 years 

Administrative 
and compliance 
costs for 
implementing 
changes (IT 
systems, legal 
advice..): 
minimal as 
provisioning is 
already part of 
SREP 
procedure 
applied to all 
EU banks, 
systems should 
only have to be 
adapted 

N/A 

N/A 

N/A 

N/A 

N/A 

66 

 
 
 
 
 
 
ANNEX 4: PROVISIONING RULES FOR PROBLEM LOANS ACROSS THE GLOBE – OVERVIEW 

Area  

Country 

Substandard 

Doubtful 

Loss 

ranges from 
30 to 91 days 
past due 

ranges from 
91 to 150 days 
past due 

ranges from 
150 to 361 
days of past 
due 

Source 

Secured or 
unsecured 
part of 
problem 
loan and 
other 
comments 

Asia- Pacific 

China 

25% 

75% 

100% 

NA 

2003 WB 

Asia- Pacific 

Hong Kong 

20-25% 

50-75% 

100% 

90<dpd<180 

dpd > 180 

Asia- Pacific 

Indonesia 

NA 

NA 

NA 

Asia- Pacific 

India 

15% secured 

25% 
unsecured 

100% 

25% for 
secured 
doubtful < 1Y 
pd  

40% for 1Y < 
secured in 
doubtful 
category < 3Y.  

100% for 
unsecured and 
secured 
doubtful > 3Y  

Asia- Pacific 

Japan 

15% (2003) 
dpd < 180 

70% (2003) 

100% (2003) 

67 

% range 
depends on 
partly 
secured/un
secured. % 
are 
“benchmar
k 
provisionin
g levels” by 
CA 

Requireme
nt 
mentioned 
in BCBS 
stocktake 
2015 but % 
not 
available 

Entire loan 
should be 
written off 
for 
category 
“loss”  

2003 WB, 
Hong Kong 
Monetary 
Authority 

BCBS 
stocktake 
2015 

BCBS 
stocktake 
2015, 
Reserve 
Bank of 
India 2015 

Unsecured 
part (%  to 
value net of 
collateral 
value) 

BCBS 
stocktake 
2015 

2003 WB  

 
 
Asia-Pacific 

South Korea 

20% 

50% 

100% 

Asia- Pacific 

Singapore 

10% 

50% 

100% 

Asia- Pacific 

Thailand 

NA 

NA 

NA 

Europe 

Albania 

Min 20% 

Min 50% 

Min 100% 

61 < dpd <90 

91 < dpd< 
180 

dpd > 180  

BCBS 
stocktake 
2015 

2003 WB  

BCBS 
stocktake 
2015  

BCBS 
stocktake 
2015  

2014 WB 

higher 
provisionin
g 
requiremen
ts for 
residential 
housing 
and credit 
card loans 
relative to 
corporate 
loans in 
place since 
December 
2006 

Unsecured 
part (% to 
value net of 
collateral 
value) 

Requireme
nt 
mentioned 
in BCBS 
stocktake 
2015 but % 
not 
available 

Unsecured 
part (% to 
value net of 
collateral 
value) 

Europe 

Bosnia 

16%-40% 

41%-60% 

100% 

2014 WB 

90 <dpd<180 

181<dpd<270 

dpd > 271 

Europe 

Georgia 

30%  

50% 

100%  

31<dpd<90  

91<dpd<120 

dpd > 150 

61<dpd<120 

121<dpd<150 

Europe 

Kosovo 

Min 20% 

Min 50% 

Min 100% 

61 <dpd< 90 

91 <dpd< 180 

dpd > 180  

68 

2014 WB 

2014 WB 

Dpd 
calibrated 
on fully 
secured 
and 
partially 
secured/un
secured 
loans.  

Unsecured 
part (% to 
value net of 
collateral 

 
 
 
value) 

Europe 

Macedonia 

20%-45% 

45%-70% 

70%-100% 

2014 WB 

61<dpd<120 

121<dpd<240 

dpd > 241  

Europe 

Montenegro 

20%-40% 

70% 

100% 

91<dpd<270 

271<dpd<364 

dpd >365 

2014 WB 

Unsecured 
part (% to 
value net of 
collateral 
value). 
Write off 
NPL after 
24 months  

Europe 

Russia 

20% 

50% 

100% 

2003 WB 

Europe 

Serbia 

15% 

30% 

100%  

60<dpd<90 

91<dpd<180 

dpd >180  

Europe 

Turkey 

NA 

NA 

NA 

Unsecured 
part (% to 
value net of 
collateral 
value) 

2014 WB, 
EBRD 
feedback 
2016 

% not 
available 

BCBS 
stocktake 
2015  

European Union 

EU 

Czech Republic 

20% 

50% 

100% 

2014 WB 

91<dpd<180 

181<dpd<360 

dpd>360 

EU 

Croatia 

30-70% 

70-100% 

100% 

181<dpd<270 

271<dpd<365 

Dpd > 365 

EU 

Hungary 

11% 

31% 

71% 

EU 

Poland 

20% 

50% 

100% 

60<dpd<90 

91<dpd<180 

dpd >181  

69 

Unsecured 
part (% to 
value net of 
collateral 
value) 

Unsecured 
part (% to 
value net of 
collateral 
value) 

2014 WB, 
EBRD 
feedback 
2016 

2014 WB, 
EBRD 
feedback 
2016 

Unsecured 
part (% to 
value net of 
collateral 

2014 WB, 
EBRD 
feedback 
2016 

 
 
 
 
 
EU 

Romania 

20% 

50% 

100% 

0<dpd<30 

31<dpd<60 

dpd>90 

value). 
Write off 
NPL after 
12M  

2014 WB, 
EBRD 
feedback 
2016 

Legal source 

Unsecured/
secured 

Source 

New Annex 
IX, BdE 
accounting 
powers 

Ranges 
depends on 
secured/un
secured 

BCBS 
stocktake 
2015 

Member 
State 

Binding/non-
binding 

Provisioning 
calendar 

ES 

Spain 

Provisioning 
calendar 
depending of 
time and the 
kind of the 
portfolio (on 
unsecured 
part, i.e. 
collateral to 
be deducted 
from amount 
of the loan 
before 
provisioning 
applied) 

Provisioning % 
are offered in 
the accounting 
circular 
(binding 
regulation) as 
an alternative 
to the use of 
estimations of 
provisions 
derived from 
banks’ internal 
accounting 
methodologies; 
such alternative 
solutions are to 
be used by 
banks unable to 
develop sound 
accounting 
methodologies 
for collective 
estimations of 
provisions (e.g. 
lack of 
appropriate 
data). 
Additionally, 
the 
provisioning 
percentages are 
to be used as 
benchmarks for 
the different 
portfolios by 
banks 
developing 

Euro Area 

Write offs 
calendar 
(excluding 
write offs in 
case of 
bankruptcy 
proceedings) 

100% write 
offs for: 

•  Doubtful 

exposure > 
4Y past due 
or 

•  Doubtful 

unsecured 
exposure < 
4Y past due 
and with 
100% 
provisionin
g for at 
least 2Y 

•  Doubtful 
secured  
exposure < 
4Y past due 
and with 
100% 
provisionin
g for at 
least 2 
years and 
effective 
collateral < 
10% GBV 

70 

 
 
 
 
 
their own 
collective 
estimations and 
by supervisors. 

Slovenia 

Binding 

Latvia 

Non-binding 
but “Basis for 
supervisors’ 
analysis and 
comparisons” 
(i.e. benchmark 
levels) 

Applied if 
supervisors 
consider 
institution’s 
assessment to 
unsatisfactory 

Portugal 

Non-binding 
comply-or-
explain 
prudential 
guidance  

Loans 
Substandard 
Min 30% 
Doubtful Min 
60%  

Loss Min 
100% 

Substandard 
= 31< dpd 
<90 

Doubtful = 
91< dpd < 
180 

Loss = dpd > 
180  

Minimum 
level of 
provisioning 
for NFC loans 
depending on 
the 
occurrence of 
specific 
conditions. 

7 impairment 
intervals are 

BCBS 
stocktake 
2015 and 
WB 2003 

Distressed 
loans (H 
loans) to be 
written off 
after 180 
dpd 

2015 Bank of 
Slovenia 
Regulation on 
the 
assessment 
of credit risk 
losses of 
banks and 
savings banks 

FKTK 
Regulations 
on Valuation 
of Assets and 
Supervisory 
Provisioning 

(amended in 
2015) 

Circular No 
02/2014/DSP 

IDB 2011 

2003 WB 

IDB 2011 

Dynamic 
provisions 
available: 
higher 
provisionin
g when 
bank’s 
credit 
growth 
exceeds 
pre-
determined 

•  Unsecured 
loans or 
exercised 
contingency  
off balance 
sheet > 1Y 
past due 

•  Loans or 
exercised 
contingency 
secured by 
real estate 
collateral 
off balance 
sheet > 4Y 
past due 
and no 
realization 
of collateral 
during 4Y 

71 

 
 
 
 
 
  
provided and, 
for each 
interval, 
specific 
conditions 
are 
described. 

Area  

Country 

Substandard 

Doubtful 

Loss 

ranges from 
30 to 91 days 
past due 

ranges from 
91 to 150 days 
past due 

ranges from 
150 to 361 
days of past 
due 

Latin 
America 

EC 

NA 

NA 

Ecuador 

Latin 
America 

MX 

Mexico 

 NA 

NA  

Latin 
America 

PE 

Peru 

 NA 

NA  

100% 
consumer 
loans > 
120dpd, 
commercial 
loans > 
270dpd, 
microcredit > 
90dpd, 
mortgage 
loans > 
730dpd  

100%  
consumer 
loans > 
126dpd, 
commercial 
loans > 
240dpd, 
microcredit > 
126dpd, 
mortgage 
loans > 
210dpd  

100% 
consumer 
loans > 
120dpd, 
commercial 
loans > 
365dpd, 
microcredit > 
120dpd, 
mortgage 
loans > 
365dpd  

threshold 

Source 

Secured or 
unsecured 
part of 
problem 
loan and 
other 
comments 

IDB 2011 

IDB 2011 

IDB 2011 

Dynamic 
provisions 
available: 
higher 
provisionin
g when 
GDP growth 
exceeds a 
threshold. 

72 

 
 
  
  
BCBS 
stocktake 
2015 

Requireme
nt 
mentioned 
in BCBS 
stocktake 
2015 

Uniform 
Retail 
Credit 
Classificati
on and 
Account 
Manageme
nt Policy, 
65 Fed. 
Reg. 36903 
(June 12, 
2000) 

Middle East 

SA 

NA 

NA 

NA 

Saudi Arabia 

North 
America 

Unites States 

Banks must 
suspend and 
reverse 
interest 
income on 
NPLs once 
the loan is 90 
dpd on any 
payment or is 
deemed 
uncollectible 
in whole or in 
part (i.e., the 
non-accrual 
principle 

“Charge off” 
of consumer 
loans after 
120 days past 
due for a 
closed-end 
(instalment) 
account. In 
lieu of 
charging off 
the entire 
loan balance, 
loans with 
non-real 
estate 
collateral 
may be 
written down 
to the value 
of the 
collateral, 
less cost to 
sell, if 
repossession 
of collateral is 
assured and 
in process. 

“Charge off” 
of consumer 
loans after 
120 days past 
due for a 
closed-end 
(instalment) 
account. In 
lieu of 
charging off 
the entire 
loan balance, 
loans with 
non-real 
estate 
collateral may 
be written 
down to the 
value of the 
collateral, 
less cost to 
sell, if 
repossession 
of collateral is 
assured and 
in process. 

“Charge off” 
of consumer 
loans after 
180 dpd:  

(i) Unsecured 
open-end 
(revolving) 
account.  

(ii) Open- and 
closed-end 
loans secured 
by residential 
real estate, a 
current 
assessment 
of value 
should be 
made by 180 
dpd. Any 
outstanding 
loan balance 
in excess of 
the value of 
the property, 

73 

 
 
 
 
less cost to 
sell, should 
be classified 
Loss and 
charged off. 

74 

 
 
 
 
 
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76