This week the EC presented concrete steps to tackle non-performing loans, see this page.

Ouch One and Ouch Two

Two reasons why this is an interesting proposal. First, it forces banks to deduct any provisioning shortfalls directly from Common Equity Tier 1. Ouch! Second, the proposal amends the CRR, which is a Regulation. And we know that Regulations are more potent than directives.Regulations apply directly to all EU banks. No country can tweak these rules in their own favor. Ouch!

A peek under the bonnet

The EC proposal adds a new regulatory deduction to Article 36 1 of the CRR. This deduction (m) is “the applicable amount of insufficient coverage for non-performing exposures.” The EC then introduces three new CRR Articles: 47a, 47b and 47c. The first two of these articles define Non-performing exposures (NPLs or NPEs) and Forbearance measures. The last of these three determines the Deduction for non-performing exposures, which is the amount of insufficient coverage for NPLs that Article 36 1 (m) then deducts from CET1.

The deduction is the sum of:

• the unsecured part of each NPL times a factor ranging from 0.28 for young NPLs that are less than 90 days past due to 1.00 for NPLs that are more than 90 days past due and which have been identified as non-performing for more than 2 years.
• the secured part of each NPLtimes a factor ranging from 0.04 for young NPLs that are less than 90 days past due to 1.00 for NPLs that are more than 90 days past due and which have been identified as non-performing for more than 8 years.

Note, each of these parts are net of other adjustments and deductions.

This is basically the core of the effects on capital.

It is interesting to see how this plays out, as banks apparently have a choice to provision via the accounting (IFRS 9) or to rely on CRR Article 36 1 (m). I guess this explains the use of the term statutory prudential backstop.

The proposal to accelerate the reduction of non-performing loans applies only to exposures incurred from 14 March 2018 onward.