A Strategy for Resolving Europe’s Problem LoansAnna Ilyina (IMF)

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• Scale of the• Scale of the NPL problem

• Macro-financial implications

• Institutional obstacles to NPL resolutionNPL resolution

• A strategy to tackle high NPLs

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tackle high NPLs

Europe’s NPLs after the Global Financial Crisis(scale; persistence)

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N f i L R i 2008 14Nonperforming Loan Ratios, 2008–14

Green = less than 5% ; Yellow = between 5% and 10%; Red = above 10%

2008 Postcrisis Peak 2014

Sources: FSIs and country authorities. Note: The FSIs are computed using consolidated bank data and therefore do not reflect only domestic NPLs. For example, in Spain the postcrisis peak and 2014 figures based on domestic data only are above 10 percent (13.5 percent and 12.5 percent, respectively).

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NPLs: Euro Area vs. Non-Euro Area Countries(mostly the same banks in both EA and non-EA high NPL countries)

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Europe: Gross NPLs, 2008-2014 (in percent of total loans)

0 10 20 30 40 50

LuxembourgFinland

2014 Peak 2008

0 10 20 30 40 50

2014 Peak 2008

SwedenSwitzerland

EstoniaGermany

NetherlandsAustria

BelgiumFranceLatvia

Sl kR bli

Euro area countries

NorwayUnited Kingdom

TurkeyIcelandBelarus

DenmarkPoland

C h R bli NSlovak RepublicLithuania

SpainMalta

PortugalSlovenia

ItalyIreland

Czech RepublicRussia

KosovoMacedonia, FYR

MoldovaBosnia & Herzegovina

RomaniaHungary

Non–euro area countries

IrelandGreeceCyprus

HungaryCroatia

BulgariaMontenegro

UkraineSerbia

AlbaniaSan Marino

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San Marino

Sources: FSIs; country authorities; and IMF staff calculations. Note: EA average NPL ratio = 10.4%; non-EA average NPL ratio = 11.2% as of end-2014

Banks with higher NPLs are less profitable, have lower capacity to generate capital, have higher funding costs and lend less

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20.2 82

Euro Area: NPLs and Bank Performance (in percent)

0

1

0.0

0.1

Interest Income to Gross Loans 1/(relative to average [6.0])

scaled to left axis

CET1 Ratio (relative to average [11.1])

4

6

8

1

1.5

2Funding Costs 2/ Lending Growth (y/y) 3/

(relative to average [-1.2])scaled to right axis

-2

-1

-0.2

-0.1

-2

0

2

-0 5

0

0.5

-4

-3

-0.4

-0.3

1 2 3 4 1 2 3 4

Banks with low NPLs high NPLs

Banks with low NPLs high NPLs

-6

-4

-2

-1.5

-1

-0.5

0-10 10-20 20-30 >30 1 2 3 4

Banks with low NPLs high NPLs

Banks with low NPLs higher NPLs

1 2 3 4 1 2 3 4NPL Ratio Quartiles NPL Ratio Quartiles NPL Ratio QuartilesNPL Ratio Quantiles

Sources: Bloomberg L.P.; EBA; SNL; Amadeus database; national central banks; Haver Analytics; Bankscope; and IMF staff calculations. Note: CET1=common equity tier 1 capital ratio. 1/ the annual interest income to gross loans, for over 100 euro area banks, relative to the annual average for banks with the same nationality, over the period 2009–13. 2/ the average funding cost for each bank, which was defined as [interest expenses/(financial liabilities retail deposits)] sovereign bond yield (5 year average); 3/ annualized lending growth

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defined as [interest expenses/(financial liabilities-retail deposits)]-sovereign bond yield (5-year average); 3/ annualized lending growth relative to average lending growth in the same country, using data from the European Banking Authority for a sample of more than 60 banks over the period 2010–13.

High NPLs also reflects weak corporate or HH balance-sheets (debt overhang), which weigh on investment and consumption

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Europe: NPLs vs. Corporate Debt-at-Risk (in percent)

2012

2013

20102011

2012201314

16

18

20Euro area countries *Non-euro area countries **

2009

2010

20112009

6

8

10

12

NPL

Rat

io

2005

200620072008

2005

20062007

2008

y = 0.9x - 19R² = 0.72

0

2

4

6

20 25 30 35 40

Sources: Orbis; IMF’s FSIs; and IMF staff calculations.Notes: (*) Cyprus, Greece, Iceland, Italy, Portugal, and Spain; (**) Bulgaria, Croatia, Hungary, Latvia, Lithuania, Serbia, and Slovenia. The x axis shows the total debt owed by firms reporting a negative

20 25 30 35 40

Share of debt owed by weak firms in total corporate debt

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The x-axis shows the total debt owed by firms reporting a negative debt-to-EBIT ratio in percent of total debt owed by sample firms in each country and each year.Sources: Orbis; IMF’s FSIs; and IMF staff calculations.

Write-off rates in Europe are too low

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Sources: ECB; National central banks; IMF, Financial Soundness Indicators; and IMF staff calculations.

Institutional factors matter: NPL disposal, pricing gap and capital relief/loss.

7Simulation: Capital Relief from NPL Reduction – Aggregate Results

Average Foreclosure Times and NPL Ratios (years/percent)

50

60

8

10EUR bln

% of banks' total assets

Uniform haircut

Capital relief

30

40

6

8

re p

erio

d (y

ears

)

ratio

(pe

rcen

t)

Uniform haircut10% haircut -6 05% haircut 24 0.1no haircut 54 0.2

C t ifi h i t b d

10

20

2

4

Fore

clos

ur

NPL

rCountry-specific haircuts, based on

10% internal rate of return (IRR) and full foreclosure time -10 0

10% internal rate of return (IRR)

Sources: Bankscope; EBA; ECB; Haver Analytics; ECB; World Bank Doing Business Survey (2014); RBS Credit Strategy; European Mortgage

00

CYP

GR

EIT

ASV

KBG

RR

OU

MKD

SVN

HR

VPO

LSR

BH

UN

CZE IR

EPR

TFR

ABE

LES

TLV

ALT

ULU

XA

UT

DEU ES

PN

LD FIN

and foreclosure time reduced by 2Y 19 0.1

5% internal rate of return (IRR) and foreclosure time reduced by 2Y 62 0.2

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Sources: Bankscope; EBA; ECB; Haver Analytics; ECB; World Bank Doing Business Survey (2014); RBS Credit Strategy; European Mortgage Federationnational central banks; and IMF staff calculations. Note: The assumption of a uniform haircut highly simplifies the impact of the pricing gap. In practice, the selling price would reflect the expected foreclosure time and expected return for distressed debt investors. Calculations are based on bank-by-bank data from the EBA Transparency Exercise (2013). The sample comprises 22 European countries (14 euro area, six non-euro EU, and two non-EU countries). Results for Cyprus are not shown for formatting reasons. No capital relief for Germany, since net NPLs are below their historical average. The whiskers indicate the results for a +/–5 percentage point deviation from the 5 percent haircut assumption.

Structural/Institutional Obstacles to NPL resolution

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1. Bank Supervision: weaknesses in banks’ NPL management capacity; collateral valuation/write off modalities; capital adequacy and provisioningvaluation/write-off modalities; capital adequacy and provisioning.

2. Legal System: deficiencies in the corporate and household insolvency/debt resolution regimes; debt enforcement and other aspects of the judicial system.g ; p j y

3. Distressed debt market: deficiencies in market infrastructure; restrictions on buying/selling distressed assets; (e.g., in the euro area, the distressed debt

k t 6 9% f NPL i 2013)market was ~6.9% of NPLs in 2013).

4. Information: limitations of credit bureaus; cadastral system; real estate transaction registers; debt counseling; supervisory reporting, as well as g ; g; p y p g,information restrictions due to consumer/data protection laws.

5. Tax Regime/other: tax deductions for provisions/write-offs; l f bli dit

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role of public creditors.

IMF Survey on Obstacles to NPL Resolution in Europe: Design

Country survey: 19 countries* with peak NPL ratio>10% (2008-14)

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/* Albania, Bosnia and Herzegovina (B&H), Croatia, Cyprus, Greece, Hungary, Iceland, Ireland, Italy, Latvia, Lithuania, Macedonia, Montenegro, Portugal, Romania, San Marino, Serbia, Slovenia, and Spain; (for B&H – separate responses from two jurisdictions)j )

Bank survey: 10 banking groups** with operations in countries covered in the country survey/** Alpha Bank, Intesa, NBG, Piraeus, Pro Credit, Raiffeisen, Societe Generale,

Unicredit, Eurobank, and Erste Group.

Questions: QQualitative: level of concern about obstacles to NPL resolution in

each of the five key areas on a 3-point scale: “3” = high, “2” = medium, and “1” = no concern

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g , ,Factual: specific obstacles in each area (country survey only)

IMF Survey Results (problems interlinked; worse in legal system and distressed debt markets)

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IMF Survey-based Scores on Obstacles to NPL Resolution(by country and by area; each score = max (country survey; bank survey))

Information Supervisory framework

Tax regimeLegal

framework Distressed

debt market Composite

scoreEA 2.6 2.5 3.0 3.0 3.0 2.8NEA 2 0 2 3 1 6 2 5 3 0 2 3

Institutional Obstacles Scores

( y y y ; ( y y; y))

NEA 2.0 2.3 1.6 2.5 3.0 2.3NEA 1.8 2.0 2.8 2.1 2.7 2.3EA 2.4 1.8 2.0 2.4 2.7 2.3NEA 1.7 2.3 2.0 2.0 3.0 2.2NEA 1.8 1.8 2.0 2.3 3.0 2.2NEA 1.8 1.8 2.0 2.1 3.0 2.1NEA 2.0 1.5 1.8 3.0 2.0 2.1NEA 1.3 1.5 2.0 2.0 3.0 2.0EA 2.2 2.0 1.0 2.5 2.0 1.9NEA 1.8 1.3 2.0 2.0 2.5 1.9NEA 1.8 1.5 2.3 2.0 2.0 1.9EA 1.4 1.8 1.0 2.3 3.0 1.9

Coun

trie

s

A .4 .8 .0 .3 3.0 .9NEA 2.0 2.0 1.2 1.7 2.0 1.8EA 1.8 2.0 1.3 1.4 2.0 1.7NEA 1.8 1.5 2.0 1.7 1.0 1.6EA 1.8 1.5 2.0 1.7 1.0 1.6EA 1.0 1.3 2.0 2.0 1.0 1.5EA 1 2 2 0 1 0 1 0 2 0 1 4

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EA 1.2 2.0 1.0 1.0 2.0 1.4EA 1.0 1.0 1.0 1.0 1.0 1.0Avg 1.8 1.8 1.8 2.0 2.2

Note: Degree of concern: “3” = high, “2” = medium, and “1” = no concern

IMF Survey Results (bigger challenges in non-euro area countries)

Average Obstacle Scores by Area: EA and non-EA countries

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2.5Information

Euro area countries Non-euro area countries

2.5Information

SEE Other CESEE

1 0

1.5

2.0

Legal framework

Tax regime

1 0

1.5

2.0

Legal framework

Tax regime

1.0

Supervisory Distressed

1.0

Supervisory Distressed p yregimedebt market

p yregimedebt market

11Note: Degree of concern: “3” = high, “2” = medium, and “1” = no concern

IMF Survey Results and NPL outcomes(more severe obstacles worse NPL outcomes)

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Composite Obstacle Scores vs NPL ratios (2014)

R² = 0.4045

50

Composite obstacle score

R 0.40

30

35

40

14)

10

15

20

25

NPL

rati

o (2

01

0

5

1 2 3

Notes: Composite score is a simple average of obstacle scores in each of the five areas;

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Notes: Composite score is a simple average of obstacle scores in each of the five areas; Degree of concern: “3” = high, “2” = medium, and “1” = no concern

A Three-Pillar Strategy for Tackling NPLs

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More assertive supervisionInternational experience: swift loss recognition (Sweden, Korea).

Reforming debt enforcement and insolvency regimesInternational experience: (i) liquidation of non-viable debtors (Ireland, Indonesia Thailand Turkey Japan and Korea); (ii) rehabilitation of viableIndonesia, Thailand, Turkey, Japan, and Korea); (ii) rehabilitation of viable debtors through insolvency procedures/out-of-court workout

Developing distressed debt marketsDeveloping distressed debt marketsInternational experience: AMCs used for NPL disposal/corporate restructuring (Sweden, Indonesia, Malaysia, Korea, and Thailand; Spain (SAREB) and Ireland (NAMA))

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(SAREB) and Ireland (NAMA))

Tighten regulation and accounting standards

14More realistic accounting

standardsIMF Survey

standardsSpecific guidance on provisions.Consistent, time-bound write-off

requirements. Bank supervision (overall score)

Conservative valuation of collateral.Non-accrual principle past set delinquency.

P d ti l Collateral related iss es

NPL management issues in banks

( )

Prudential measuresTime limits / write-down targets. Higher capital charges on long-held

NPLs

Insufficient bank capitalization

Collateral-related issues

NPLs.Triage approach. Standardized criteria

for separating non-viable firms (liquidation) from viable firms

1.0 1.5 2.0 2.5 3.0

Insufficient level of supervisory attention to NPLs

f hi h di d

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( qu dat o ) o ab e s(restructuring loans) (e.g., Korea).

Note: Degree of concern: “3” = high, “2” = medium, and “1” = no concern

Reform debt enforcement and insolvency regimes…

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Foreclosure/debt enforcement IMF Survey

Less costly and protracted procedures implies more effective and predictable asset recovery.

Limit appeals; short preclusiveLegal Obstacles (overall score)Limit appeals; short preclusive

deadlines.

Institutional framework

Deficiencies in judicial system

(overall score)

Institutional frameworkEfficiency of institutional framework

can be even more important than formal laws Deficiencies in the household

l

Deficiencies in the corporate insolvency regime

formal laws.Specialized judges and insolvency

administrators/ performance-based fee structure (metric: rapid return

1.0 1.5 2.0 2.5 3.0

insolvency regime

Note: Degree of concern: “3” = high, “2” = medium, and

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( pto productive value of assets). “1” = no concern

…and remedy other legal issues.16

Tax regime IMF Survey

Tax deductibility of loan loss provisions / write-offs.

No taxation of debt forgiveness (i.e.,

Tax deductions for loan write-offs are not allowed in about 60 percent of surveyed countries.

No taxation of debt forgiveness (i.e., no income recognition of concessions granted to distressed borrowers)

Tax deductions for loan-loss provisions are allowed in most cases, but often subject to a cap.

Public creditors

All creditors should be involved and affected by the restructuring

Often public creditors have priority over private creditors claims, cannot provide debt write-off.

affected by the restructuring process. Often there are no effective

mechanisms for info sharingbetween private and public creditors

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creditors

Kick-start a market for distressed debt

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Reduce barriers to entryLicensing, legal impediments to bilateral sales and non-bank/foreign ownership, compliance cost, tax considerations, uncertainty about (duration of) asset recovery

i d b i f iImprove access to (consistent) debtor informationAsset registers, credit bureaus.

Encourage a wide range of risk-sharing techniquesg g g qStructured finance e.g., NPL securitization.Asset Management Companies (AMCs) (private/public) …

Economies of scale (asset recovery marketability investor interest)Economies of scale (asset recovery, marketability, investor interest)

Bargaining power (size and centralization of collateral)

Specialization enables bank to focus on lending

Combine with robust supervision and insolvency reforms17

Combine with robust supervision and insolvency reforms.

An AMC would need to be compatible with EU state aid rules

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In some cases, public support may be needed to overcome the pricing gap…

EU state-aid rules

Any transfer of public resources defined as state-aid.

Requires bail-in of creditors under BRRD (with systemic exemptions).

A state-aid compatible AMC model:

Assets sales at market price (or using accepted pricing methodology where no market exists). Therefore no transfer of public resources.

Minority public stakey p

Voluntary participation

Clear mandate / Transparent governance

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Conclusions

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Europe has (too) high NPLs and (too) low write-off rates.

This holds back credit and impedes economic recovery.

Several structural obstacles hinder timely resolution.

Combined action needed in three areas:More assertive supervision.

Reforming debt enforcement and insolvency regimes.

Developing distressed debt markets.

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Role of European Institutions: Issues for Discussion

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European CommissionEuropean CommissionGuidance needed on ex ante permissibility of AMCs in cases when some public subsidy is necessary to close pricing gap.

European financial institutions (EIB/EIF, EBRD)Promote transparency/good governancePromote transparency/good governance

Help develop NPL resolution strategies

NPL securitization?

Support establishment of country-specific or regional AMCs for CESEE distressed debt ?

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