Handling troublesome loans: scope for business and minimising losses

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A common problem facing credit institutions is the accumulation of non-performing loans (NPLs), which affects their ability to issue new loans. To set up an integrated financial system and allow banks to focus on new lending, there are plans to adopt a common mechanism across the EU aimed at minimising NPL volumes and preventing their accumulation in future. This article explores some of the proposed solutions to tackle NPLs.
Non-performing loans
An NPL is a loan on which the borrower is unable to make the scheduled interest payments or principal repayments. If payments are more than 90 days overdue or if repayment is assessed as unlikely, the loan is classified as an NPL. Large NPL volumes adversely affect the bank’s operations in the following two main ways:
  1. NPLs reduce the bank’s income and profitability, with potential losses reducing its capital. In the worst case, this may threaten the bank’s viability;
  2. The bank allocates significant human and financial resources to recover its NPLs. This reduces the bank’s ability to lend to small and medium entities that badly need bank loans to expand their business.
And the unreasonable expense that banks incur in handling and recovering NPLs puts a burden on the courts and insolvency proceedings.
Earlier this year, the European Commission issued a number of proposals for NPLs. Banks will be required to set aside sufficient resources for cases of new loans becoming NPLs, thus creating appropriate incentives to tackle NPLs at an early stage and prevent their excessive accumulation. The following two main solutions are proposed for tackling NPLs:
  1. an accelerated out-of-court enforcement procedure that targets collateral;
  2. developing the secondary NPL market.
Accelerated collection of collateral
Although many NPLs are secured loans and the banks can recover the collateral through insolvency and debt collection proceedings, this process may be slow and its outcome unpredictable. As a result, NPLs stay on the bank’s balance sheet for a long time, keeping the bank from lending to local and foreign companies, or forcing it to increase its lending fees. This in turn prevents borrowers from approaching creditors in other member states. This hinders the free movement of capital, adversely affecting the functioning of the common market.
A solution that would make debt collection proceedings more efficient is to ensure that the loans are recovered by adopting an accelerated out-of-court procedure that targets collateral across the EU. Removing the uncertainty about the outcome of the enforcement procedure would stimulate more cross-border lending.
This procedure would be available if the lender and borrower agreed on this in advance in their loan agreement. This would not apply to consumer loans and would not affect the hierarchy of creditors in the event of insolvency.
Benefits for debt collection service providers
Efficiently managing an NPL portfolio requires resources and special expertise that the bank may be unable to provide in certain cases. Banks may lack employees with specific knowledge of a particular loan, while adopting procedures for attracting employees and tackling NPLs cause costs that may come close to the NPL portfolio’s total value. In such cases, the best plan is to engage specialist service providers or to sell the NPL to a buyer that is willing to take the risk and has NPL management expertise.
The different NPL rules in member states hinder the development of an efficient secondary NPL market. The activities of persons buying bank loans are not regulated in some member states, while others have adopted a number of requirements, including the one for taking out a banking licence. Buyers may legally operate in one member state and face obstacles to buying NPL portfolios from the banks in other member states. This means that overall the internal competition between NPL portfolio buyers is limited.
To improve the situation, it is crucial to adopt common standards and harmonise NPL portfolio buyers’ market access across the EU, including reduced market-entry and loan-handling costs. These steps would encourage competition between NPL portfolio buyers, boost demand, and raise deal prices.
A precondition for economic growth is adopting efficient mechanisms to improve credit institutions’ ability to recover loans completely or partially. So adopting the Commission’s proposals would become an important step in ensuring the EU banking sector’s growth and stability and promoting welfare across the EU.


Maris Butans
PwC Legal
Tel: +371 67094400
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