On 20 March, the European Central Bank (ECB) published a guide on non-performing loans ("Guidance to banks on non-performing loans", the Guidance) for banks. Said Guidance was published after a process beginning in 2014 when the ECB identified the key risk for Eurozone banks as the existence and maintenance of what the European Banking Authority (EBA) has defined as non-performing exposures (NPE; the acronyms NPL and NPE shall be used interchangeably), i.e., all credit exposures with more than 90 days’ non-payment ("past -due criterion") and in respect of whose debtor has been determined as unlikely to be able to meet all of the payment obligations without resorting to the enforcement of guarantees (unlikely-to-pay criterion").

Thus, in July 2015, a high-level task force (made up of personnel from the ECB and the relevant national agencies) was tasked by the Supervisory Board of the ECB to develop a universal supervisory strategy for the regulatory treatment of NPLs for banks.

On the basis of the work of the high-level group, bank supervision by the ECB has identified a number of good practices which are set out in this Guidance and shall represent the ECB's supervisory expectations.

Although the Guidance is not binding in nature, it is necessary to state that the criteria, recommendations and parameters included are part of the so-called soft law. The failure to comply with the provisions of soft law is not punishable via traditional means, although so-called soft coercion does exist, which has its own means of punishment mainly affecting the reputation of the bank in question.

Its practical effects should be considered insofar as the relevant supervisor shall use said criteria for their initial evaluations of the overall performance or the assessment of possible signs or alarms to decide whether or not to rule out a possible request for information or even greater involvement and further investigation and inspection.

Thus, the Guideline itself warns that any deviation from its provisions must be clearly justified and explained at the supervisor's request; it shall also be considered under the Single Supervisory Mechanism during the performance of its supervisory review and evaluation functions. Thus, non-compliance may lead to the adoption of supervisory measures. 

The Guidance is a supervisory tool with the aim of clarifying the supervisory expectations regarding NPL identification, management, measurement and write-offs in areas where existing regulations, directives or guidelines are silent or lack specificity.

The Guidance is applicable, from its publication date, to banks with non-performing exposures, whether these are substantial or relevant or not, without prejudice to the fact that, pursuant to the principle of proportionality, the organisational requirements and qualitative and quantitative resources may be adjusted to the circumstances of the size of the bank or volume of exposures.

Concerning the structure of the Guidance's content, the ECB has attempted to follow the life cycle of NPL management by banks.

Thus, it begins by developing the supervisory expectations for NPL reduction strategies that must be followed by high NPL banks; these expectations must be realistic but sufficiently ambitious, establishing the banks' approach in a clear, credible and feasible manner for each relevant portfolio, regarding the maximisation of recoveries (effective management) and the ultimate reduction of NPEs. Governance and internal control aspects relating to the strategy for NPL stocks are covered in the following chapter, establishing specific functions that the management body must carry out within the NPL strategy framework and the operational plan, as vital parts of the overarching strategy of the bank. Matters such as the NPL operating model, internal control framework and NPL monitoring and early warning processes are also covered in this chapter.

Chapter 4 sets out important aspects for the handling or the granting of forbearance measures, providing guidance on how to distinguish between viable and non-viable measures based on practical experience related to the most common short and long term measures, with particular attention given to the assessment of the borrower's capacity to pay. This chapter also includes guidelines relating to the summary of supervisory reporting and public disclosures.

Chapter 5 seeks to provide a brief overview on selected issues regarding the need to converge on the notion of non-performing exposure in order to make common identification possible in accordance with the EBA definition and thus to reach a balanced treatment, as well as some examples of good practice to reduce the differences in its recognition.

The qualitative guidelines for provisioning are set out in chapter 6 which aims to foster the adequate measurement of impairment provisions across all loan portfolios through sound and robust methodologies; timely recognition of loan losses and the enhancement of procedures.

Lastly, chapter 7 addresses collateral valuation for immovable property and sets out the supervisory expectations and provides guidelines on the policies, procedures and disclosures of information which banks should adopt when valuing immovable property held as collateral for NPLs. Under the Single Supervisory Mechanism (SSM), banks are expected to adhere to the principles presented and incorporate these principles into their policies, procedures and controls.

Ultimately, the ECB has included in this Guidance the parameters which they consider essential without being exhaustive or exclusive in order to guarantee (and require) adequate management of the levels of non-performing exposures maintained currently by most banks throughout the Eurozone that limit the possibilities of more credit flowing to the productive sectors of the actual economy, to SMEs and individuals.

Adequate management necessitates greater involvement of the management and senior management bodies of banks to define the strategies for reducing these exposures within a sequential and delimited timescale and within the key strategies of the banks. Senior management must also be responsible for establishing, maintaining, reviewing and updating all procedures necessary to guarantee the identification of exposures, the viability of the forbearance measures, the capacity and technical experience of teams internally assigned to the management and reduction of non-performing exposures, the management and enforcement of guarantees and an adequate methodology for the accounting of exposures.

In addition, parameters must be determined for monitoring the correlation between credit risk estimations and capital requirements and provisioning strategies for the reduction of exposures taking into account the circumstances of the market, counterparts, possible recipients of divestment strategies, deductions or discounts applied to make divestment feasible in both the short and long term or the correction of possible deviations in the estimations of items in the general budgets of the bank and in business plans.

As the ECB itself made public in a press release, the Guideline shall henceforth form part of the permanent supervisory dialogue with banks and the ECB shall apply the principle of proportionality, adjusting the level of intrusiveness according to the severity of the situation, its deterioration and the volume of non-performing exposures on the banks' balance sheets.

Supervisors have already made initial contact with high NPL banks, contact that shall continue following the publication of the Guidance's final text and shall include, in the near future as part of normal supervisory activities, sending communications to those banks to ensure that they observe the supervisory expectations for the management and treatment of NPLs.

The ECB also asks governments to act with determination and to adapt their legal and judicial frameworks to allow banks to reduce their NPLs.