COMMISSION STAFF WORKING DOCUMENT EXECUTIVE SUMMARY OF THE 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

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   EUROPEAN COMMISSION  Brussels, 14.3.2018  SWD(2018) 74 final  COMMISSION STAFF WORKING DOCUMENT  EXECUTIVE SUMMARY OF THE 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) 73 final}  
 
 
Executive Summary Sheet 

Impact assessment accompanying a proposal to amend Regulation (EU) No 575/2013 as regards minimum 
loss coverage for non-performing exposures 

A. Need for action 

Why? What is the problem being addressed?  
Following the financial crisis, the regulatory framework for banks has changed substantially. Reforms agreed 
at the level of the G20 and the Basel Committee have been and are being implemented around the globe in 
order  to  reduce  the  risk  in  the  banking  sector  and  to  make  the  financial  system  more  stable  and  resilient. 
Nevertheless,  some  risks  have  been  addressed  only  locally.  In  particular,  major  jurisdictions  (such  as  the 
United  States  or  Japan  to  name  just  a  few)  have  taken  a  number  of  measures  to  reduce  the  level  of  non-
performing loans (NPLs) and repair banks’ balance sheets, inter alia by introducing or intensifying mandatory 
provisioning/writing-off regimes for NPLs. 
NPLs and other and other non-performing exposures (NPEs)1 have also piled up in parts of the EU banking 
sector  in  the aftermath  of  the  financial  crisis  and  ensuing  recessions.  These  elevated  levels  of  NPLs  affect 
financial stability as they weigh on the profitability and viability of the affected credit institutions and have an 
impact, by reduced bank lending, on economic growth. To further address the challenges of high NPLs in the 
EU, the "Action Plan to Tackle Non-Performing Loans in Europe" by the ECOFIN Council calls upon various 
institutions and agencies to take appropriate measures. 
In particular, to reduce the risk of new NPL problems arising in the future, one of the key policy areas is to 
ensure that NPLs are recognised in a timely way and covered adequately in order to prevent loss forbearance 
and  enhance  NPLs  resolution.  Under-provisioning  and  loss  forbearance  are  major  obstacles  to  debt 
restructuring  or  asset  sales,  since  banks  may  postpone  restructuring  or  deleverage  in  order  to  avoid  loss 
recognition (so-called "wait-and-see" approach). Delays in loss recognition have been found to contribute to 
reduced lending, as delays put even more pressure on banks to increase provisions during stress times (i.e. 
when  losses  materialise  and  regulatory  capital  requirements  become  most  binding).  This  pro-cyclical 
provisioning implies pro-cyclical bank lending and more ample swings in the business cycle (i.e. boom-bust 
credit cycles). 
Addressing high stocks of NPEs as well as their possible accumulation in the future is an important part of the 
Union’s  efforts  to  further  reduce  risks  in  the  banking  system  and  enable  banks  to  focus  on  lending  to 
businesses  and  citizens.  On-going  discussions  in  the  Council  confirm  that  further  advances  in  addressing 
NPLs are essential to complete Banking Union which forms a top priority in the Leaders’ Agenda. 

What is this initiative expected to achieve?  
The general objectives of this initiative, which is part of a broader package of measures to tackle the issue of 
NPLs  in  the  EU,  are  two  fold  and  mutually  reinforcing:  the  first  general  objective  is  to  limit  risks  that  high 
levels  of  NPEs  pose  to  financial  stability  by  avoiding  the  build-up  or  excessive  increase  of  insufficiently 
covered NPEs in the EU banking system; second this initiative aims at ensuring that EU banks have sufficient 
loss coverage for NPEs, 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, thus supporting investment, growth  and 
employment. 
Operationally, this is pursued by reducing both the ability and the incentives of banks to pursue "wait and see" 
and "extend and pretend" strategies, by which banks delay the recognition of NPLs provisions. The initiative 
would  do  so  by  introducing  a  statutory  prudential  backstop  which  consist  of  (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-performing  ("minimum  coverage  requirement"),  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  from  Common  Equity  Tier  1  (CET1)  items.  The  minimum  coverage  requirement  would 
apply  in  full  only  after  a  certain  period  of  time,  which  would  be  different  whether  the  loan  is  secured  (by 
collateral or guarantee) or not. 

1  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. The 
terms NPE(s) and NPL(s) are therefore used interchangeably within this document. 

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What is the value added of action at the EU level?  
The  current  EU  prudential  framework  does  not  provide  for  a  common  minimum  treatment  with  regards  to 
incurred/expected losses on NPLs. Supervisors 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),  but  no  harmonised  (minimum)  treatment 
applicable across Member States and banks can be imposed. 
Due to the lack of common prudential rules on NPLs provisioning, actual loss coverage for NPLs may vary 
across  banks  in  different  jurisdictions  even  if  they  bear  the  same  underlying  risk.  This  may  limit  the  cross-
country  comparability  of  capital  ratios  and  undermine  their  reliability.  Banks  with  the  same  risk  profile  and 
sharing the same currency (for those in the euro area) would face different funding conditions depending on 
where they are located. Furthermore, on the borrowers’ side, two companies with identical risk profiles and 
the  same  currency  would  face  different  lending  conditions  depending  on  their  establishment.  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. 
Legislative action on the EU level would put 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.  It  would 
contribute  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 Banking Union by putting all 
banks  on  an  equal  footing,  reducing  unnecessary  differences  in  banks'  practices,  increasing  comparability, 
facilitating  market  discipline  and  promoting  market  confidence.  EU  wide  action  would  also  reduce  potential 
spill-over effects within the Union. The high interconnectedness within the EU (and especially within the euro 
area)  financial  system  creates  a  significant  danger  of  spill-overs  entailing  stability  risks  which  are  better 
addressed at EU level. 

B. Solutions 

What  legislative  and  non-legislative  policy  options  have  been  considered?  Is  there  a  preferred 
choice or not? Why?  
The Impact Assessment has considered the following policy options (on top of the baseline scenario i.e. no 
EU action): 
  Option 1 – full coverage requirements of unsecured and secured NPLs at the end of defined time periods 

without any coverage requirement beforehand; 

  Option 2 – gradually (linearly or progressively) increasing coverage requirements starting after the 

classification as non-performing and leading to a full coverage of unsecured and secured NPEs at the 
end of defined time periods; 

  Option 3 – for secured NPLs, application of haircuts depending on the type of collateral (unsecured NPLs 

would be treated as under Option 1 and 2). 

Upon evaluation and consideration of the impacts, option 2 (applying a progressive path to full coverage) was 
found  to  be  preferable,  because  it  achieves  the  policy  objectives  whilst  maximising  the  cost-benefit  ratio.  It 
strikes  the  right  balance  between  leaving  sufficient  time  for  possible  recoveries  and  avoiding  abrupt  cliff-
effects after this period of time.  

Who supports which option?  
Option 1 has been opposed by most of the stakeholders as it requires full coverage of NPLs only at the end of 
the  defined  time  periods  which  could  lead  to  important  cliff-effects  for  banks  that  would  be  subject  to  a 
deduction from their own funds. 
Option  2  (gradual  approach)  was  supported  by  some  banks  and  most  of  the  public  stakeholders.  Banks 
showed  a  preference  for  a  progressive  path  rather  than  a  linear  one,  as  the  latter  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. 
Option 3 (approach based on haircuts) has been criticised by most of the private and public stakeholders as 
being unduly complex. The majority of stakeholders did not find added value in it, as the complexity and the 
additional  implementation  costs  would  outweigh  the  small  benefits  banks  would  get  in  terms  of  higher  risk-
sensitivity. 

C. Impacts of the preferred option 

What are the benefits of the preferred option (if any, otherwise main ones)?  
Option  2  (gradual  approach)  would  require  banks  to  start  covering  their  NPLs  at  an  early  stage,  therefore 

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strongly  reducing  both  their  ability  and  their  incentives  to  "wait  and  see"  and  "extend  and  pretend".  This 
objective would be quickly met, as the coverage requirement would by design kick in as soon as the exposure 
becomes non-performing. Banks 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 would have fewer cases 
to impose or maintain dedicated Pillar 2 measures 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  lower 
coverage levels during the first years when the collateral is more likely to be realised. 

What are the costs of the preferred option (if any, otherwise main ones)?  
Option 2 would induce higher costs in terms of capital requirements and implementation costs compared to 
the  baseline  for  banks  not  currently  subject  to  any  Pillar  2  measures  increasing  their  NPLs  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 NPLs. 
Option 2 would potentially be costlier than Options 1 and 3 in the short run, as the potential deduction would 
apply already in the first year following the classification as NPL, 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 time for banks to recover the loan or realise the collateral at 
the beginning. 

How will businesses, SMEs and micro-enterprises be affected?  
The application of minimum coverage requirements would reduce banks’ incentives and ability to pursue "wait 
and  see"  practises.  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,  both  in  terms  of  credit 
quantity and price. The positive impact should be to the benefit of SMEs in particular, since these are more 
dependent on bank lending than large corporates which might access more easily financial markets.  

Will there be significant impacts on national budgets and administrations?  
Significant impacts  on national budgets and  administrations are not expected. The introduction of a Pillar 1 
measure should reduce the need for Pillar 2 measures (which are assessed on a case-by-case basis). This 
would allow for a more targeted use of human and financial resources, thereby increasing efficiency. 

Will there be other significant impacts?  
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 
across  banks  and  promotes  a  level-playing  throughout  the  Single  Market.  Because  of  the  progressively 
increasing  coverage  requirements  possible  cliff-edge  effects  as  result  of  delayed  losses  with  potentially 
severe  impacts  on  banks'  capital  would  be  avoided.  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). 
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 strengthening their resilience to stress 
times  and  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). 

D. Follow up 

When will the policy be reviewed?  
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. 

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