In another step towards completing the banking union, the European Commission is proposing measures to help develop secondary markets for non-performing loans (NPLs). The proposal forms part of a package of measures, presented by the Commission on 14 March 2018, to further reduce risks in the banking sector. The measures should speed up the progress already made towards reducing the level of existing NPLs in Europe and preventing the build-up of too many new ones in the future (see previous article).

Status quo

At the moment, the secondary market for distressed assets is not able to absorb the large potential supply of NPLs in Europe. Official statistics are hard to come by, but according to some major consultancies, there was less than €120 billion in transactions in loan sales in 2016. This is in spite of the fact that, at €910 billion (at the end of the third quarter of 2017), the total volume of gross NPLs in the EU remains high. Some Member States are further along than others. But overall, markets tend to be small and underdeveloped.

There are a number of issues plaguing secondary markets. One problem is that, while there are large numbers of NPLs on European banks' balance sheets, there are relatively few investors willing and able to buy them. Potential investors find it difficult to enter the market because buying NPLs is complex and the relevant rules differ considerably across Member States. Obtaining information on the quality of the loans and interpreting it is also an obstacle. These factors lead to a large gap between the price investors are bidding for NPLs and the price banks are prepared to accept. This often results in transactions that are negotiated over a long time or not concluded at all. The scarcity of loan servicers – independent firms that manage and collect loans – is another barrier discouraging NPL investors from entering the market.

In the absence of a properly functioning secondary market, banks have to deal with NPLs internally, in order to recover value. In some cases, they are not able to do this effectively and efficiently. This hampers banks’ ability to lend to new customers.

Range of measures

The proposals being put forward are the result of work that in part involves the European Central Bank (ECB) and the European Banking Authority (EBA), as well as the Commission. The Commission's proposal for a directive, which forms part of the package of measures, aims to improve the conditions for market entry for NPL buyers and loan servicing firms by establishing EU-wide rules for both purchasers and servicers of bank loans that is simpler than the ones many Member States have in place now. For instance, the proposal defines the activities of credit servicers, sets common standards for authorisation and supervision, and imposes conduct rules across the EU. As such, the proposal facilitates cross-border activities. Furthermore, while loan purchasers will not be subject to authorisation requirements, investors purchasing bank loans have to notify authorities when acquiring the loan. Non-EU purchasers of consumer loans, meanwhile, must use authorised EU credit servicers. Other safeguards will ensure that borrower rights remain the same if a credit is transferred from a bank to an investor.

A key measure in the package aims to improve transparency by making data more readily available and easier to compare. One of the reasons NPL markets in Europe have not developed further is the absence of accessible, easy-to-compare data on loan, debtor and collateral characteristics. Consequently, the Commission in 2017 asked the EBA to work on achieving a certain level of standardisation of loan information. The fruit of this work was the launch in December of harmonised data templates. These templates will help facilitate greater transparency and comparability of information.

In addition, the Commission is working with the EBA and the ECB to explore potentially setting up an NPL transaction platform. A platform could help further increase transparency, reduce transaction costs and limit coordination problems arising from multiple creditors having a claim on a specific borrower.

The Commission has also set out non-binding technical guidance (a ‘blueprint’) for how national asset management companies (AMCs) can be set up. AMCs can be private (created by one or more banks), or (partly) publicly supported. An AMC could act as a catalyst for market development by entering the market as a large buyer of NPLs, lifting depressed market prices in the process. Furthermore, there could potentially be considerable synergies between an AMC and an NPL transaction platform, in that the former could use the latter as a means by which to reach investors.

All of these measures need to be seen as a whole. Taken separately, they may not be enough to resolve the problem of the EU's large, systemic NPL stocks. But together, the different elements of the action plan should make a substantial contribution to reducing NPLs in Europe now and in the future. And fewer NPLs will make for more stable banks that are better able to lend to households and businesses.

Read more on non-performing loans