As widely reported by Italian blog Phastidio.net the recent addendum to ECB’ Guidelines on NPL management has triggered several negative reactions from Italian editors and politicians. The main concern seem to be that new severe regulation may increase significantly the expected provisions and therefore hurt Italian banks and depress their market capitalization. Hence the need to defend local champions against the bad German bureaucrat.
There is a Latin motto to describe this
Excusatio non petita, accusatio manifesta
it means that defensing oneself before anyone have started accusing is equivalent to admit to be guiltily.
So if central bank is simply recommending fair accounting of NPLs those who claim excessive austerity are implying not only that current internal guidelines are inadequate but also that the cost of revising them is hardly bearable, and by contrasting the request of additional transparency they are saying that this issue is not a relevant priority.
My view is in order to take the opportunity to campaign against austerity and European entities little attention has been paid to the detail of the specific document and to the global framework proposed by ECB.
Let’s try to understand it better.
What exactly is asking ECB in this addedum?
First of all let’s point out that guidelines are not a binding rules: it is a reasonable suggestion on the behavior expected under a prudential approach to NPL provisions. Secondly let’s remember that the last addendum is a draft, open to comments until December 2017.
Then what is ECB asking? That within a reasonable term a non performing exposure should be fully provisioned. The idea is at that point the credit should either be recovered to the possible extent either classified as zero recovery exposure. Please note that, deviations may be considered as clearly expressed in the picture below:
Therefore there is no mechanistic approach as Italian editors seem to believe: if relevant evidence of future collections are available the backstop may not be applied.
Since the basic concept is not too complex the seems quite reasonable according common sense, how about the time frame proposed? The term to trigger the backstop is differentiated between secured and unsecured claim:
Are these deadline appropriates? Let’s give a look to the following graph:
it is taken from a bank of Italy research paper ans shows that 7 years seem to be an appropriate term for secured loans: by that time foreclosures and restructuring agreements in Italy have collected almost everything and only bankruptcies need more time. Nevertheless enough evidence should have been collected in order to point out if further recoveries are to be expected or not.
What about 2 years for unsecured loans? It is slightly more complicated because you may have 3 cases:
- legal workout process in which enough evidence should be available to decide whether the credit should be fully provisioned or not
- positive out of court workout in which 2 years are enough because either the borrower has paid either he is still paying
- negative out of court workout where in 2 years you may not be in the position to decide if something will be collected in future or not
what can be conclude? That the suggestions works pretty well with the only issue of unsecured loans with negative out of court workout process. Let’s take a look to a table coming from another Bankit research paper
Unsecured loans recovered on average 36% in Italy between 2006 and 2015 and recovery rates are going down as also reported in the following graph
We are therefore saying that the most severe issue is 100% provisions on a portion of unsecured loans that, since no legal workout are pending or in progress and out of court recovery process was negative, have low probability to collect anything in future.
Bottom line is that ECB is asking to manage NPLs properly and within a reasonable term (in line with data available for Italy) to book 100% provisions if no relevant evidence are available of further collections (this analysis has been published in Italian on Phastidio.net blog).
As I tried to explain, ECB is only trying to propose commonsense elements in NPL management in order to achieve higher transparency and fair representation of Non Performing Exposure values on balance sheets.
Those who deem this as austerity or bureaucracy excess or mechanistic approach have either misunderstood the content of the document (and the nature of guidelines that are not binding neither unconditional automatic rules) either accused Italian banks of beeing unprepared to apply fair accounting rules. In this last option they believe that transparency is low priority issue and “not hurting banks” is so important that keeping NPL on book at unrealistic values may be accepted.
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GLG – Gerson Lehrman Group – Council Member