In short, improving the overall environment for NPL resolution would afford an opportunity not only to repair bank balance sheets, but also those of their clients. Both of these are ultimately necessary to achieve a sustainable recovery in bank lending, and in doing so to restore the effectiveness monetary policy transmission. Finally, banks’ incentives are necessarily affected by regulation. This is indeed its purpose. Regulation aims to internalise negative externalities, but it is the nature of regulating that policymakers must always be watchful that, in the process, they do not inadvertently create new forms of negative externalities. Regulations passed so far have rightly aimed to make banks internalise systemic risks and markets to better price them. And there is in principle no long-run trade-off between higher  5  For a discussion of how NPLs can affect cost efficiency see Berger A.N., and R. DeYoung (1997), “Problems Loans and Cost Efficiency in Commercial Banks”, Journal of Banking and Finance, Vol. 21. 6  World Bank (2013), Doing Business 2014: Understanding Regulations for Small and Medium-Size Enterprises. 4  BIS central bankers’ speeches  capital and higher lending. 7 But at the same time, much depends on the calibration of specific requirements, and here very careful macroeconomic impact assessments are required – for instance, to ensure that the transitional costs of implementing regulations do not have unwanted effects on credit.

And this depends in turn on several factors at the national level including the efficiency of insolvency regimes, out-of-court restructuring frameworks and judicial systems. For example, differences between countries in the speed of insolvency proceedings can affect the ability of banks to seize collateral, and hence influence their incentives and ability to resolve NPLs. To illustrate, according to the World Bank, to resolve insolvency in Italy takes 1.8 years, compared with just 0.4 years in Ireland. 6 Ineffective insolvency systems also render out-of-court restructuring frameworks less operable, as they fail to act as a credible threat, thereby dissuading creditors and debtors from agreeing on a restructuring. This latter point may be particularly important because, in a debt overhang environment, the overall efficiency of NPL resolution and the cost for society hinges crucially on the ease with which debt can be restructured outside of the insolvency framework. For firms whose business models remain fundamentally viable, liquidation may be economically inefficient and some form of voluntary debt restructuring could be essential to restore their viability and allow them to borrow and invest again. Several countries have already made progress in reforming their national legislation. To give just one example, in Portugal the government introduced new regimes for fast-track in-court and formalised out-of-court restructuring in 2011 and 2012. Experience has shown, however, that the effectiveness of an improved legal framework depends on various accompanying factors, such as improving debtor-creditor coordination and building sufficient administrative and judicial capacity to successfully mediate restructuring.