Some commentators are worried about the impact that recently published Addendum to ECB guidelines on NPL management could have on banks provisions and lending capacity. The idea is that stricter requirements could push banks to increase provisions on NPEs and, especially for unsecured loans, reduce the convenience of lending.
My take on this is that direct effect will be quite limited while the most relevant perspective should be Moral Suasion.
First and Foremost, guidelines are not binding rules like those included in European Commission NPL Package (statutory prudential backstops)
therefore no bank will be forced to increase provisions on NPL due to some mechanic application of an updated accounting principle.
Secondly, as I explained in this post the timeline proposed to increase provisions is consistent even with Italian sluggish Judicial system so what is ECB asking is supposed to be already in place in the most advanced banks and should not require an exceptional effort for other players.
Finally, the way asset quality review works is applying a detailed analysis of single relevant roles assessing the updated an most realistic liquidation values of existing guarantees. If an updated and realistic forecast of expected recoveries on the single loan justifies a level of provision lower than the one set by guidelines than this will be accepted by ECB.
So what is all this fuss about?
ECB is suggesting that banks should have a proactive approach to credit management and that the improvement in workout efficacy and efficiency should allow to update provisions in order to make them more consistent with what will be actually collected.
It is not about increasing provisions for sake of austerity or excessive caution, but much more about running properly credit management process and updating accounting values in order to maintain a fair representation of financial situation.
Within 2 years the workout process for an unsecured loan should have been either completed either brought to a stage in which is pretty clear the extent of claim residual claim that can still be collected. If this is true than ECB guidelines are even redundant (as they could actually be they could actually be after the new European Commission package).
If this is not true then the problem is not only the lack of efficiency but mostly the unfair representation of financial situation: balance sheet include claims that will never be collected and when the level of trust from market operators fells below a critical threshold we will experience real troubles and the recent experience of Monte dei Paschi di Siena and Venete Banks stand as hard lesson on this.
My conclusionas are that
- ECB Guidelines will not have a dramatic impact because they are based on best practices already existing and not really difficult to match
- they will have a cost due to investments in workout operations and/or outsourcing fees as well as limited increase in prudential capital buffers
- they will bring substantial gains due to increased transparency of balance sheets and via augmented trust by market operators, reduced cost of funding as well as increased equity evaluation
GLG – Gerson Lehrman Group – Council Member