NPLs resolution regimes: Challenges for regulatory authorities

Abstract

Banks around the globe are struggling with high levels of non-performing loans (NPLs). The crisis and subsequent recession have left businesses and households in many countries with over-indebtedness, which depresses consumption and investment. Significant banking sector resources are absorbed by legacy assets that make banks more reluctant to extend credit and support new viable investment projects. NPLs resolution is needed in order for banks to resume lending and the issues should be addressed with some form of central intervention, that is, government assistance. Two approaches are available: the creation of a bad bank, which aggregates all NPLs; or the creation of internal work-out units within the banks for specialised management of problematic loans. The optimal solution is not unique and depends on the economic and political environment, the institutional framework as well as the intensity of the problem. Whatever solution is chosen, however, it poses specific challenges for regulatory authorities both from a macroprudential and a microprudential perspective. From a macroprudential perspective the NPLs resolution policy, the NPLs persistence and toxicity, the adverse feedback loop in macrofinancial linkages, the form of intervention and private debt overhang are considered. From a microprudential perspective, the supervisory protection layers, the data adequacy for credit assessment as well as challenges from the new business model, are of interest. Finally, the theoretical analysis is supported by international evidences.