No Vaccination Against Bad Loans

Keynote of Prof. Dr. Joachim Wuermeling, Deutsche Bundesbank, at NPL Forum in Frankfurt am Main.

“NPL dismantling” provides one of the keywords for the speech of Prof. Dr. Joachim Wuermeling, Member of the board of the Deutsche Bundesbank. In his keynote at the Frankfurt School’s NPL Forum he widens the view and takes a look to Europe. “Because: When it comes to NPL, we have to think and act European. Even if the stocks of non-performing loans in Germany are low, they can become a problem elsewhere in the euro area, initially for the respective country itself, but also for the euro area as a whole.” He sheds light on three aspects.

  • First: “In the past few years, we have made important progress in reducing the NPL in the euro area. While the NPL inventory of significant institutions in the euro area was almost € 1 trillion in mid-2016,” says Joachim Wuermeling, “it had more than halved by the end of last year, to just under € 450 billion.” However, the stocks are still very unevenly distributed across the countries of the euro area. Key milestones in this NPL decline were the ECB’s 2017 NPL Guide and the 2018 Addendum. The guide primarily targets non-performing loans that were built up during the financial crisis. “The addendum, on the other hand, formulates supervisory expectations for risk provisioning for new NPLs, so it has a preventive effect. However, following the progress made in reducing the NPL in recent years, the pandemic could now turn the trend.”
  • That is Joachim Wuermeling’s second point: a renewed spike in non-performing loans is probably only a matter of time in the euro area. As soon as the support measures expire, he expects to see an increase in the NPL level. “Basically it is of course part of the banking business that individual borrowers get into payment difficulties; that cannot be avoided at all. Banks must write-down or write-off loans as necessary, and they must collect and dispose of collateral. But here, too, the dose makes the poison”, warns Joachim Wuermeling. Through higher provisions, rising NPL stocks have a negative impact on the already weak profitability of European banks. This could also affect their solvency as a result. The higher the NPL rate in the system and the more uncertain the economic situation, the more likely investors and depositors are to question the quality of bank balance sheets and the ability of the institutions to make further value adjustments and absorb possible losses. “It is therefore important to take countermeasures now”, Joachim Wuermeling calls for action. “This will pose challenges in particular for those institutions and countries that already had a high level of non-performing loans before the pandemic began.”
  • Supervision and politics are already acting, says Joachim Wuermeling. In December 2020 the ECB sent another “Dear CEO Letter” to the significant institutes. “Among other things, it makes it clear what to expect in terms of risk provisioning. It also collects information on how banks deal with credit risks and how they determine the necessary risk provisions. There is no intention or reason to soften the ambitious NPL rules. And the EU Commission is also providing important impetus with its NPL action plan of December 2020. In this plan, the Commission proposes new measures and takes up the outstanding aspects of the 2017 Council NPL Action Plan. The Commission wants to facilitate the handling of Covid-related NPLs at an early stage and thus prevent a renewed accumulation of non-performing loans on European bank balance sheets.” The focus is on measures to promote secondary markets, set up asset management companies and improve insolvency frameworks. The Commission also comments on precautionary public support measures.

With a view to the secondary markets, the main thing is more transparency. The Commission’s proposals could make an important contribution here, says Joachim Wuermeling: a common data set and data standard for NPL transactions within the EU would make the markets more transparent. Data quality, data comparability and data infrastructure are the key words.

Joachim Wuermeling also welcomes the Commission’s proposal to set up and network national Asset Management Companies – AMCs for short. “However, this must be done on a voluntary basis, without community funding and in accordance with EU state aid rules.”

AMCs have already proven themselves in the past as a tool for NPL reduction. By means of economies of scale, better coordination of creditors and the pooling of expertise, they can help to clean up bank balance sheets. “The proposals in the action plan are correct – but they must also be taken up and followed up.” Joachim Wuermeling points to some initiatives: the EBA is currently consulting its standardized NPL data templates, which have been reduced in scope, and the Commission is putting its proposal for a European data hub up for public discussion by early September.

Ultimately, however, the banks themselves have to set up value adjustments in good time and in line with the risk in order to counter an increase in non-performing loans. “This is probably the most important lever to arm yourself for a Europe-wide increase in non-performing loans and to prevent negative repercussions on the real economy”, says Joachim Wuermeling.

This is how he sums up his remarks at the Frankfurt School:

  • First: “We must not allow ourselves to be lulled into deceptive security by the still low number of corporate insolvencies. As soon as the state aid runs out, bankruptcies are likely to rise. The rise in non-performing loans should be limited for German credit institutions. Nevertheless, caution remains the order of the day.”
  • Second: “The German banks are in good shape. They are more resilient and better equipped with capital than they were a few years ago. But they have to catch up in risk management: they have to create more transparency with regard to credit risks and improve their data skills.”
  • Third, bad loans are a European issue: “After the progress made in recent years in reducing NPLs, the pandemic could now turn the trend. It is all the more important to take countermeasures now. The EU Commission does this with its NPL Action Plan of December 2020. Now it is time to implement the proposed measures.”

There is no vaccination against bad loans. Nevertheless, banks have many options for getting themselves into a form in which post-Covid cannot harm them.

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