Case study: Standardising the definition of non-performing exposure and forbearance

Case study: Standardising the definition of

non-performing exposure and forbearance

Overview and implementation in the context of the Asset Quality

Review (AQR)

Contents

i.

Importance of definitions of non-performance exposure (NPE) and forbearance

ii.

NPE and forbearance: Our experience with standardisation

i. Overview of the definitions

ii. Common ground and obstacles

iii. What did we do and what did we not do

IMPORTANCE OF DEFINITIONS OF NPE AND FORBEARANCE

Case study: Standardising the definition of non-performing exposure and

forbearance

NPE and Forbearance: Analysis and action

• Not all EU jurisdictions have a definition of NPE:

• 11 EU jurisdictions have a definition in their supervisory framework connected to existing concepts of impairment or default (but no jurisdiction has the same definition!).

• 15 EU jurisdictions do not have a supervisory definition of NPE and use accounting or regulatory concepts instead (but various practices in the implementation of default and impairment!).

• Credit classification schemes: May be linked to definitions of NPE (substandard and below) or replace them when there is no definition (but categories within schemes not always identical!).

• In some jurisdictions banks may use their own definitions of NPE (not the same!).

• Most EU jurisdictions identify in the accounting or regulatory framework exposures modified due to difficulties of the debtor … but forbearance concept itself is rarely used (used instead: modified, renegotiated, renewed, restructured etc.).

Action:

• Supervisory action hindered by semantic/definitional issues

• Impossible to identify levels or trends of NPE in a truly comparable way in the single market.

• In the absence of pressure to recognise forbearance as such, extend and pretend become prevalent.

NPE AND FORBEARANCE: OUR EXPERIENCE WITH STANDARDISATION

Case study: Standardising the definition of non-performing exposure and

forbearance

Overview of the definitions

Non-performing

past due more than 90 days and / or unlikely to pay

Defaulted

Impaired

All other non-defaulted and non-impaired loans and debt securities and off-balance sheet exposures meeting the generic criteria

Fair value option

Fair value through other comprehensive income

Amortised cost

Generic criteria:

off-balance sheet items:

Loan commitments given

Financial guarantees given (except derivatives) Other commitments given

Performing Fully perfoming

Loans and debt securities that are not past-due and without risk of non-repayment and performing off-balance sheet items

Performing assets past due below 90 days

Loans and debt securities between 1-30 days past due

Loans and debt securities between 31-60 days past due

Loans and debt securities between 61-90 days past due

Performing assets that have been renegotiated

Loans and debt securities which renegotiation or refinancing did not qualify as forbearance

Forbearance

Forborne loans and debt

securities (and eligible off-balance sheet commitments) performing or non-performing Refinancing Modifications of terms and conditions Other

NPE and forbearance: Further explanation of the

definitions

Definitions cover loans, debt securities and off-balance sheet commitments (no trading exposures).

An NPE is an exposure that is 90 days past-due (dpd), unlikely to be repaid in full without collateral realisation (even if current or below 90 dpd), impaired or defaulted:

• Creditworthiness approach: Classification of the gross outstanding without consideration of collateral, • exposure can be performing on an individual or debtor basis but all exposures to a debtor are

non-performing when on-balance sheet exposures more than 90 days past-due > 20% of the on-balance sheet exposures to the debtor,

• exit criteria: The exposure is not impaired, not defaulted, and does not have any amount past-due by more than 90 days – a NPE that is granted forbearance must subsequently remain NPE for at least one year.

Forbearance measures are concessions towards a debtor facing or about to face financial difficulties; a forborne exposure can be performing or non-performing:

• Modification of the terms and conditions of the contract or total or partial refinancing that would not have been granted had the debtor not been in financial difficulties,

• safety nets: Mandatory classification as forborne when the modified or repaid exposure is non-performing, total or partial cancellation through write-off, or the exposure is 30 days past-due (rebuttable),

• discontinuation of forbearance classification after a probation period (two years) and only if the exposure is performing and the debtor has demonstrated its capacities of repayment – stricter rules for forborne NPE.

The starting point and work: Common grounds

and obstacles

Common ground:

• Existing regulatory frameworks, e.g. CRR’s 90 dpd definition for a defaulted obligor,

• and impaired exposures according to the applicable accounting framework (and as such

automatically referring to the impairment triggers according to IAS 39 like e.g. “significant

financial difficulty of the issuer or obligor”).

Supervisory reporting definitions of NPE and forbearance that provide for harmonisation in

the EU without modifying the existing concepts of impairment and default

Difficulties:

• Accountings vs. regulatory requirements / definitions, e.g. no consideration of “incurred

but not reported” (IBNR) losses when defining NPE,

• implementation of new concepts (especially forbearance): Increased quality over time,

• regulatory forbearance?

Focus on regulatory reporting – or: What did we

do and what did we not do

What we did do …

• Develop harmonised definitions (in the form of an ITS) for NPE and forbearance with a focus on semantics: One approach for a common understanding,

• definition of benchmarks for asset quality assessment (e.g. assessment tools in the Asset Quality Review [AQR]),

• considering existing regulatory, accounting and legislative frameworks as well as practices from

banks in the member states (e.g. referring to the 90 dpd definition in the CRR).

… and what we did not do …

• No change of accounting and regulatory standards: No definition of regulatory or accounting metrics to be used to estimate capital requirements, RWA and impairment,

• no impact on the legal bankruptcy/solvency regimes (the definitions leave out collateral)

• no change in the existing credit classification schemes at the national level (the definitions are for FINREP)

• no full transparency (yet): Definitions used in supervisory reporting (not always public) even if some banks have started disclosing on a voluntary basis.

… and what we are still working on:

• Work at international level on the comparability of credit classification schemes and NPEs. •

IMPACT IN PRACTICE

Case study: Standardising the definition of non-performing exposure and

forbearance

The use of the definitions in the AQR

Definitions of NPE and forbearance were an essential piece of the recommendations used

during the AQR and have allowed to:

• Draw the same line for all institutions between performing and non-performing

exposures,

• compare asset quality in a homogeneous and comparable way across EU institutions,

• improve the starting point data of the stress tests.

Definitions of NPE and forbearance were used on a best effort basis according to the ECB

simplified approach (SSM jurisdictions) or other simplifications (non-SSM jurisdictions)

using the core harmonisation features:

• Every material exposure that is 90 dpd even if it is not recognised as impaired or

defaulted,

• every exposure that is impaired or defaulted (GAAP or IFRS) without taking collateral

into consideration,

• exposures classified as non-performing on a transaction basis (for retail) and on a

AQR: Impact of reclassifications in the Eurozone –

an asset class view

For the SSM, the use of the harmonised NPE definition has resulted in EUR 54.6 bln additional NPE (EUR 743.1 bln to EUR 797.7 bln, i.e. 40% of the overall increase due to the AQR):

Lessons learnt and next steps

Identifying Non-performing exposures is a complicated process (different definitions and

legal frameworks) and it needed a crisis to achieve even small steps.

Definitions find a common base to allow for a better understanding of

Non-performing/forborne exposures across the Single Market, but do not solve complexity.



The definitions do not by themselves modify existing classification schemes and their

peculiarities.

Important next steps to ensure a lasting impact of the harmonisation effort in the EU:



Setting-up of the formal reporting process (first data collected on 31/12/2014) and

inclusion of the data in risk analysis works/procedures of supervisors.



Embedding of the definitions into supervisory action (e.g. AQR) so that they have an

impact on banks.



Transparency to ensure the level of risk according to the harmonised concepts of NPE

and forbearance is appropriately known by markets and serves market discipline.



Harmonisation at the international level for global comparability and coordinated

actions.

13

EUROPEAN BANKING AUTHORITY

Tower 42, 25 Old Broad Street London EC2N 1HQ

Piers Haben, Director, Head of Oversight Tel: +44 20 7382 1753

E-mail: [email protected] http://www.eba.europa.eu