Non-performing loan

Non-performing loans are generally recognised as per the following criteria:{{cite journal|date=June 2005|title=Clarification and Elaboration of Issues Raised by the December 2004 Meeting of the Advisory Expert Group of the Intersecretariat Working Group on National Accounts|url=http://www.imf.org/external/pubs/ft/bop/2005/05-29.pdf|publisher=INTERNATIONAL MONETARY FUND}}{{Cite web|date=2020-12-20|title=What are provisions and non-performing loan (NPL) coverage?|url=https://www.bankingsupervision.europa.eu/about/ssmexplained/html/provisions_and_nplcoverage.en.html|access-date=2021-02-14|website=European Central Bank - Banking Supervision|language=en}}

• Payments of interest and principal are past due by 90 days or more
• At least 90 days of interest payments have been capitalized, refinanced or delayed by agreement
• Payments are less than 90 days overdue, but there are other good reasons to doubt that payments will be made in full.

In general, the management of NPLs is made difficult due to a variety of reasons:

• Lack of a standard, accepted definition of NPLs, and no strong reporting frameworks
• Lack of any standard valuation methodology whereby financial institutions can provision for losses arising from NPL resolution.
• Incentives for banks and financial institutions to understate their NPLs in order to avoid reputational risk of facing higher funding cost on financial markets
• Unwillingness of banks to sell NPLs because of the costs associated with such an exercise, which could add to the NPL losses. This in turn could hurt their capital adequacy.
• Consumer protection regulations{{Cite web|title=Bad debts make good profits - but what are the social costs?|url=https://www.opendemocracy.net/en/oureconomy/bad-debts-make-good-profits-what-are-social-costs/|access-date=2021-02-14|website=openDemocracy|language=en}}{{Cite web|date=2016-06-22|title=Vulture Funds in Ireland|url=https://www.financialjustice.ie/campaigns/debtcampaign/vulture-funds-in-ireland/|access-date=2021-02-14|website=Financial Justice Ireland|language=en}}

There are two main approaches for dealing with NPLs:

• A decentralized approach involves regulating banks so they take measures to prevent and resolve the NPLs in their loan books, for example by legislating accounting rules to force banks to provision against future losses, or by setting up legislative frameworks and other measures to foster a secondary market for NPLs.{{Cite web|title=Credit servicers, credit purchasers and the recovery of collateral: Fostering secondary markets for non-performing loans (NPLs) and easing collateral recovery - Think Tank|url=https://www.europarl.europa.eu/thinktank/en/document.html?reference=EPRS_BRI(2019)635514|access-date=2021-02-14|website=www.europarl.europa.eu|language=en}} In this approach, banks are left alone to manage their own bad loans by giving them incentives, legislative powers, or special accounting or fiscal advantages.
• A centralized approach takes the form of a central organization/agency such as a "bad bank" (also called "Asset Management Company").

In practice, both approaches can be used simultaneously, as illustrated by the European Commission's action plan on NPLs,{{Cite web|title=Action plan: Tackling non-performing loans (NPLs) in the aftermath of the COVID-19 pandemic|url=https://ec.europa.eu/info/publications/201216-non-performing-loans-action-plan_en|access-date=2021-02-14|website=European Commission - European Commission|language=en}}{{Cite web|date=2021-01-14|title=Non-performing loans: vote on EU rules for selling NPLs to third parties |url=https://www.europarl.europa.eu/news/en/press-room/20210111IPR95312/non-performing-loans-vote-on-eu-rules-for-selling-npls-to-third-parties|access-date=2021-02-14|website=European Parliament |language=en}} while some authors have argued that systemic crisis generally require a more centralized approach.{{cite book |last1=Ayadi |first1=Rym |title=Carving Out Legacy Assets: A Successful Tool for Bank Restructuring? : Study |date=2017 |publisher=European Parliament |isbn=978-92-846-0609-2 |oclc=1013925272 }}{{pn|date=February 2023}}

Proactive measures to tackle NPLs include:

• Impose more transparency on NPLs reporting by banks
• Accounting framework (such as IFRS9)
• Prudential Supervision of banks including the levels of capital requirements and buffers.
• Proactive incentives for banks to offer forbearance to distressed consumers and other debt relief mechanisms{{Cite web|date=2020-06-19|title=The Financialisation of Distressed Debts in Europe |website=Finance Watch|url=https://www.finance-watch.org/the-financialisation-of-distressed-debts-in-europe/|access-date=2021-02-14|language=en-US}}{{Cite web|last=Philipponnat|first=Thierry|date=2021-02-15|title=Bail out people, not banks |url=https://www.finance-watch.org/bail-out-people-not-banks/|archive-url=|archive-date=|access-date=2021-02-15|website=Finance Watch|language=en-US}}
• Setting up Asset Management Companies (AMCs) or bad banks{{Cite web|last=|first=|date=2017-07-05|title=Utilizing AMCs to Tackle Eurozone's Legacy Non-Performing Loans|url=https://european-economy.eu/2017-1/utilizing-amcs-to-tackle-eurozones-legacy-non-performing-loans/|archive-url=|archive-date=|access-date=2021-02-14|website=European Economy|language=en-US}}. These companies use public or bank funds to remove NPAs from the bank books. For example, the Korea Asset Management Corporation purchased as much as 80% of bad loans at market rate following the Asian crises.
• Fostering secondary markets for NPLs that can offer the mechanism and liquidity required to write off bad loans. Many companies see a business opportunity in buying NPL's. Buying NPL's from financial institutions with a discount, can be a lucrative business. Companies pay from 1% to 80% of the total loan and become the legal owner (creditor). The discount depends on the age of the loan, secured/ unsecured, age debtor, personal/ commercial debt, area of residence, etc.
• Securitization of NPLs (i.e. packaging a bulk of NPLs into a pooled financial product such as a covered bond or asset backed security) may help preserve the market value of the NPL package to a level closer to their nominal or real economic value, thus lessening the cost of selling NPLs for banks.{{cite journal |last1=Bruno |first1=Brunella |last2=Lusignani |first2=Giuseppe |last3=Onado |first3=Marco |title=Why We Need to Breach the Taboos on European Banks' Non-Performing Loans 56 |journal=European Economy |location=Rome |issue=1 |date=2017 |pages=113–121 |id={{ProQuest|1933125268}} |hdl=11565/3999448 |hdl-access=free }}
• Corporate Governance

Although the 2020 has seen an actual decrease of non performing loans, the issue is expected to represent a major challenge for the banking industry in the post-COVID-19 era.{{Cite web|last=Gual|first=Jordi|date=|title=The post-COVID-19 recovery: what challenges and roadmap for the banking industry?, SUERF Policy Notes .:. SUERF - The European Money and Finance Forum|url=https://www.suerf.org/policynotes/19605/the-post-covid-19-recovery-what-challenges-and-roadmap-for-the-banking-industry|archive-url=|archive-date=|access-date=2021-02-14|website=SUERF.ORG}}World Bank, 2020, [http://pubdocs.worldbank.org/en/460131608647127680/FinSAC-COVID-19-and-NPL-Policy-Note-Dec2020.pdf COVID-19 and Non-Performing Loan Resolution in the Europe and Central Asia region]{{Cite journal|last=Ratnovski|first=Lev|date=2020-05-27|title=COVID-19 and non-performing loans: lessons from past crises|url=https://www.ecb.europa.eu/pub/economic-research/resbull/2020/html/ecb.rb200527~3fe177d27d.en.html|language=en|issue=71}} The ECB has warned that the amount of NPLs in the Eurozone could reach up to 1.4 trillions euros of bad loans,{{Cite journal|last=Enria|first=Andrea|date=2020-10-12|title=Interview with Handelsblatt|url=https://www.bankingsupervision.europa.eu/press/interviews/date/2020/html/ssm.in201012~f68deb5173.en.html|journal=|language=en|volume=|pages=|via=}} however academic literature suggest the future rise of NPLs will be primarily driven by the pace of the economic recovery after COVID-19, and in particular the level of unemployment. In the context of the COVID-19 crisis, the deactivation of debt payment moratoria and tax deferral are also likely to cause an increase of NPLs.Jakob De Haan, [https://www.europarl.europa.eu/RegData/etudes/IDAN/2021/659645/IPOL_IDA(2021)659645_EN.pdf Non-performing Loans – Different this Time? NPL resolution after COVID-19], European Parliament, March 2021

To prepare for the likely new wave of NPLs, the ECB Supervisory Board's chair Andrea Enria has proposed the creation of a European Bad Bank{{Cite news|last=Enria|first=Andrea|date=26 October 2020|title=ECB: the EU needs a regional 'bad bank'|url=https://www.ft.com/content/cc3a9a51-4d9a-4c73-9ff0-9f623ecf4065|archive-url=|archive-date=|access-date=2021-02-14|newspaper=Financial Times}}{{Cite web|last=Carrascosa|first=Antonio|date=2020-12-22|title=A European Bad Bank – a necessary tool for financial stability?|url=https://srb.europa.eu/en/node/1109|archive-url=|archive-date=|access-date=2021-02-15|website=Single Resolution Board|language=en}}{{Cite web|title="A bad bank must be part of our toolbox to solve banking challenges"|url=https://www.ilsole24ore.com/art/a-bad-bank-must-be-part-of-our-toolbox-to-solve-banking-challenges-ADl1VKq|access-date=2021-02-15|website=Il Sole 24 ORE|date=18 September 2020|language=it}} and has imposed a ban on dividend distribution by banks,{{Cite journal|last=Bank|first=European Central|date=2020-12-15|title=ECB asks banks to refrain from or limit dividends until September 2021|url=https://www.bankingsupervision.europa.eu/press/pr/date/2020/html/ssm.pr201215~4742ea7c8a.en.html|language=en}} in a move to pressure banks to proactively tackle NPLs.{{Cite journal|last=Bank|first=European Central|date=2021-01-28|title=ECB asks banks to address credit risk and improve efficiency|url=https://www.bankingsupervision.europa.eu/press/pr/date/2021/html/ssm.pr210128~fabea02148.en.html|language=en}} The ECB has also indicated to work on the development of an "Amazon-style" platform to allow banks and investors to trade NPLs on a secondary market.{{Cite news|last=Scuffham|first=John O’Donnell, Matt|date=2020-09-23|title=Exclusive: ECB plots Amazon-style market to prevent Wall Street COVID debt swoop|language=en|work=Reuters|url=https://www.reuters.com/article/us-europe-loans-investors-exclusive-idUSKCN26E2EC|access-date=2021-02-15}}

Meanwhile the European Commission has revised its action plan in December 2020{{Cite web|last=|first=|date=|title=Coronavirus response: Tackling non-performing loans (NPLs) to enable banks to support EU households and businesses|url=https://ec.europa.eu/commission/presscorner/home/en|archive-url=|archive-date=|access-date=2021-02-14|website=European Commission - European Commission|language=en}} by focusing on speeding up the fostering of a secondary market for NPLs and to offer support for national Asset Management Companies. The proposal was met with criticism by civil society groups.{{Cite web|title=European Commission's 'non-performing loans' plans to leave consumers vulnerable to 'vulture funds'|url=https://www.beuc.eu/publications/european-commission%E2%80%99s-%E2%80%98non-performing-loans%E2%80%99-plans-leave-consumers-vulnerable-%E2%80%98vulture/html|access-date=2021-02-14|website=www.beuc.eu}}{{Cite web|date=2020-12-16|title=Early Christmas for European banks: Public bailouts to become the norm again |website=Finance Watch|url=https://www.finance-watch.org/press-release/early-christmas-for-european-banks-public-bailouts-to-become-the-norm-again/|access-date=2021-02-14|language=en-US}}

Non-performing property loans are found to lead to banking crises.{{Cite journal |last=Tham |first=Kuen-wei |title=Dynamic implications of GDP, interest rates, taxes, income, foreign direct investments, housing prices on property NPLs |url=https://www.emerald.com/insight/content/doi/10.1108/IJHMA-07-2021-0078/full/pdf |journal=International Journal of Housing Markets and Analysis |year=2022 |volume=15 |issue=5|pages=1122–1144 |doi=10.1108/IJHMA-07-2021-0078 |s2cid=244229109 |url-access=subscription }} The need to identify the relationships between macroeconomic factors and NPLs had been crucial for governments and financial institutions to monitor the economy and undertake necessary policies or decisions to control and reduce the number of NPPLs in the financial system. The economic crisis caused by a rise of NPPLs in any particular country had been known to spread to other economies, as seen in the United States of America’s subprime mortgage crisis. During the sub-prime mortgage crisis, the ASEAN Economic Community (AEC) has gone through difficult periods of volatile NPPLs and the issue of NPPLs remains a major challenge amongst ASEAN member countries. Early research of NPLs was dominated by internal procedures and specific attributes of the lending banks in approving, controlling and monitoring the loans to ensure they remain active and not impaired. In recent years, research showed that property loans made up the highest percentage of NPLs in countries like Malaysia and US.{{Cite journal |last=Tham |first=Kuen-wei |date=2021 |title=Non-Performing Property Loans and its Origination in the Real Estate Finance System |url=https://ejournal.um.edu.my/index.php/IJPS/article/download/25423/13472/75365 |journal=International Journal of Property Sciences |volume=11 |issue=1 |pages=35–59|doi=10.22452/ijps.vol11no1.3 |doi-access=free }} This had refocused research into the how macroeconomic conditions affect non-performing property loans.

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