NPE strategy
This section sets out the key elements for developing and implementing an NPE strategy. Credit institutions should have in place an adequate framework to identify, measure, manage, monitor and mitigate NPEs, including through workout activities.
In the development and implementation of their NPE strategies, credit institutions should take into account relevant consumer protection considerations and requirements, and ensure fair treatment of consumers.
4.1Developing the NPE strategy
Credit institutions should establish an NPE strategy to target a time-bound reduction of NPEs over a realistic but sufficiently ambitious time horizon (NPE reduction targets). The NPE strategy should lay out the credit institution’s approach and objectives regarding effective management to maximise recoveries and ultimately a reduction in NPE stocks in a clear, credible and feasible manner for each relevant portfolio. When developing and implementing the NPE strategy for retail portfolios, credit institutions should consider provisions aimed at protecting consumers, including Directive 2014/17/EU (opens EUR-Lex in a new tab), (13) Directive 2008/48/EC (opens EUR-Lex in a new tab)(14) and the EBA Guidelines on arrears and foreclosure.(15)
The following steps should form the core building blocks of the development and implementation of the NPE strategy:
a) assessment of the operating environment and external conditions (see section 4.2);
b) development of the NPE strategy over short-, medium- and long-term time horizons (see section 4.3);
c) implementation of the operational plan (see section 4.4);
d) fully embedding the NPE strategy into the management processes of the credit institution, including regular review and independent monitoring (see section 4.5).
When credit institutions develop their NPE strategy, they should also consider policies that aim to ensure the fair treatment of borrowers.
4.2Assessing the operating environment
As a first phase in the formulation and execution of an appropriate NPE strategy, credit institutions should complete an assessment of the following elements:
a) internal capabilities to effectively manage and reduce NPEs;
b) external conditions and operating environment;
c) the capital implications of the NPE strategy.
4.2.1Internal capabilities/self-assessment
Credit institutions should perform a comprehensive self-assessment to evaluate the actual situation and the steps to be taken internally to address any gaps in the internal capabilities to manage NPEs.
Institutions should fully understand and assess:
a) The magnitude and drivers of their NPEs:
the size and evolution of NPE portfolios at an appropriate level of granularity, which requires an appropriate grouping of the exposures, as outlined in section 5.2.3;
the drivers of NPE inflows and outflows, by portfolio where relevant;
other potential correlations and causations.
b) The outcomes of NPE actions taken by the credit institution in the past:
the types and nature of actions implemented, including forbearance activities;
ii. the effectiveness of those activities and related drivers.
c) Their operational capacities (processes, tools, data quality, IT/automation, staff/expertise, decision-making, internal policies and any other relevant area for the implementation of the strategy) in relation to the various steps involved in the process, including but not limited to:
early identification of NPEs;
ii. forbearance activities;
iii. impairments and write-offs;
iv. collateral valuations;
v. recovery, legal process and foreclosure;
vi. management of foreclosed assets, where relevant;
vii. reporting and monitoring of NPEs and of the effectiveness of NPE workout solutions.
Credit institutions should perform a comprehensive self-assessment covering at least the items listed in paragraph 29 on an annual basis to determine strengths, significant gaps and areas of improvement required to reach NPE reduction targets.
Credit institutions should report the outcome of the comprehensive self-assessment to the institution’s management body and the competent authority.
Credit institutions should consider seeking expert views on their operational capabilities to manage NPEs from the institution’s risk management and control functions or from external sources on a periodic basis.
4.2.2External conditions and operating environment
Credit institutions should assess and consider the current and likely future external operating conditions and environment when establishing the NPE strategy and associated NPE reduction targets. The following list of external factors, where appropriate, should be taken into account by credit institutions when setting the NPE strategy:
a) The macroeconomic conditions, including the dynamics of the real estate market or other relevant sectors, taking into account sector concentrations in NPE portfolios.
b) Market expectations with regard to acceptable NPE levels and coverage, including but not limited to the views of rating agencies and market analysts, and available research, taking proper account also of the interests of borrowers. c) NPE investor demand, including trends in and the dynamics of the domestic and international NPE markets for portfolio sales.
d) The maturity of the NPE servicing industry and the availability and coverage of specialised servicers.
e) The regulatory, legal and judicial framework. Credit institutions should have a good understanding of the legal proceedings related to NPE workout for different types of assets and different jurisdictions. In particular, credit institutions should assess the average duration of such proceedings, the average financial outcomes, the rankings of different types of exposures and related implications for outcomes, the influence of the types and rankings of collateral and guarantees on the outcomes, the impact of consumer protection issues on legal decisions, and the average total costs associated with legal proceedings. Legal provisions aimed at protecting consumers, in particular for residential mortgage exposures, should also be considered by credit institutions when setting the NPE strategy.
f) The national tax implications of impairments and NPE write-offs.
4.2.3Capital implications of the NPE strategy
Credit institutions should be able to calculate a detailed assessment of the impact of the planned strategy from capital, risk exposure amount, profit or loss, and impairment perspectives for each of the reduction drivers, and they should assess whether the bank has identified a strategic process to resolve any shortfalls under different economic scenarios. The assessment criteria, underlying assumptions and implications should be aligned with the RAF as well as with the internal capital adequacy assessment process (ICAAP).(16)
Credit institutions should include suitable actions in their capital planning to ensure that the level of available capital will enable a sustainable reduction of NPEs on the balance sheet.
4.3Development of the NPE strategy
The NPE strategy should encompass, at a minimum, time-bound quantitative NPE targets and foreclosed assets targets, supported, where appropriate, by a corresponding comprehensive operational plan. The development of the NPE strategy should be informed by a self-assessment process and an analysis of the strategic options for the implementation of the NPE strategy. The NPE strategy and operational plan should be defined and approved by the management body and reviewed at least annually.
4.3.1Strategy implementation options
Credit institutions should consider including a combination of strategies and options in the NPE strategy to achieve their objectives over the short, medium and long term. In order to successfully operationalise the NPE strategy, credit institutions should consider at least the following non-mutually exclusive implementation options for different portfolios and under different conditions:
a) Hold/forbearance strategy: suitable workout strategy and forbearance options. The hold strategy option is strongly linked to the credit institution’s operating model, forbearance and borrower assessment expertise, operational NPE management capabilities, outsourcing of servicing and write-off policies.
b) Active portfolio reductions: sales, securitisation or, in the case of NPEs that are deemed unrecoverable, write-offs. This option is strongly linked to adequacy of impairments, collateral valuations, quality of exposure data and investors’ demand for NPEs.
c) Change of type of exposure or collateral, including foreclosure, debt to equity swapping, debt to asset swapping or collateral substitution.
d) Legal options: including insolvency proceedings or out-of-court solutions.
Credit institutions should identify medium- and long-term strategy options for NPE reductions that may not be achievable immediately, for example due to a lack of immediate NPE investor demand, which might change in the medium to long term. The operational plan may therefore need to allow for such changes and require preparations for them, for example by enhancing the quality of NPE data in order to be ready for future investor transactions.
When a credit institution concludes that none of the above options will lead to a sufficient NPE reduction in the medium to long term for certain portfolios or individual exposures, this should be clearly reflected in a timely impairment and write-off approach.
4.3.2Targets
Before commencing the short- to medium-term target-setting process, credit institutions should establish a view of reasonable long-term NPE levels, both at portfolio level and at aggregate level. Credit institutions should take into account historic or international benchmarks in order to define reasonable long-term NPE levels.
Credit institutions should include, at a minimum, clearly defined realistic yet ambitious quantitative targets in their NPE strategy, including for foreclosed assets, where relevant. These targets should lead to a concrete reduction, gross and net of impairments, in NPEs, at least in the medium term. While expectations about changes in macroeconomic conditions, when based on solid external forecasts, can play a role in determining target levels, they should not be the sole driver of the NPE reduction targets established.
Credit institutions should establish targets as followings:
a) by time horizons (short-term (indicative one year), medium-term (indicative three years) and possibly long-term);
b) by main portfolios (e.g. retail mortgage, retail consumer, retail, small and medium-sized enterprises (SMEs), corporate, large corporate, commercial real estate);
c) by implementation options (e.g. cash recoveries from a hold strategy, collateral repossessions, recoveries from legal proceedings, revenues from sales of NPEs or write-offs).
The NPE targets for credit institutions should at a minimum include a projected absolute or relative NPE reduction, both gross and net of impairments, not only on an overall basis but also for the main NPE portfolios. Where foreclosed assets are material, a foreclosed assets strategy should be defined or, at least, foreclosed assets reduction targets should be included in the NPE strategy.
The NPE targets should be aligned with the more granular operational targets. Further monitoring indicators can be implemented as additional targets, if deemed appropriate.
4.3.3Operational plan
The NPE strategy of the credit institution should be supported by an operational plan, which should be defined, approved and reviewed by the management body. The operational plan should clearly define how the credit institution will operationally implement its NPE strategy over a time horizon of at least one to three years (depending on the type of operational measures required).
The NPE operational plan should contain at least:
a) clear time-bound objectives and goals;
b) activities to be carried out on a portfolio basis;
c) governance arrangements and structures, including responsibilities and reporting mechanisms for activities and outcomes;
d) quality standards to ensure successful outcomes;
e) staffing and resource requirements;
f) required technical infrastructure and an enhancement plan; g) granular and consolidated budget requirements for the implementation of the NPE strategy;
h) plans for communication with internal and external stakeholders (e.g. with regard to sales, servicing, efficiency initiatives).
The operational plan should have a specific focus on internal factors that could present impediments to the successful delivery of the NPE strategy.
4.4Implementing the operational plan
The implementation of the NPE strategy operational plan should rely on suitable policies and procedures, clear ownership and appropriate governance structures, including escalation procedures, and the operational plan should incorporate wide-ranging change management measures in order to embed the NPE workout framework as a key element in the corporate culture.
Credit institutions should report material deviations from the plan to the management body and to the competent authority in a timely manner, with appropriate remediation actions to be put in place.
4.5Embedding the NPE strategy
As the execution and delivery of the NPE strategy will involve and depend on many different areas within the credit institution, it should be embedded in processes at all levels of the organisation, including strategic and operational, including the risk committee as defined in Article 76(3) of Directive 2013/36/EU.
Credit institutions should emphasise to all relevant staff the key components of the NPE strategy in line with the approach taken to the institution’s overall strategy and in particular the risk strategy as defined in Article 76 of Directive 2013/36/EU. This is especially important if the implementation of the NPE strategy will involve wide-ranging changes to business procedures.
Credit institutions should clearly define and document the roles, responsibilities and formal reporting lines for the implementation of the NPE strategy and operational plan.
Staff and management involved in NPE workout activities should be provided with clear individual (or team) goals and incentives geared towards reaching the targets agreed in the NPE strategy and operational plan. Related remuneration policies, career development objectives and performance monitoring frameworks should take the NPE targets into account in order to ensure the full engagement of staff and management with NPE reduction and should also have regard to the fair treatment of consumers. The incentive scheme for staff and managers in the loan origination/business units should also take into account the feedback from the workout activities and the quality of the credit institution’s exposures in order to disincentivise excessive risk taking. With regard to retail exposures, these remuneration policies should be developed in accordance with the EBA Guidelines on remuneration policies and practices related to the sale and provision of retail banking products and services.(18)
All relevant components of the NPE strategy should be fully aligned with and integrated into the business plan and budget, including all the relevant costs associated with the implementation of the operational plan, and also potential losses stemming from NPE workout activities.
The NPE strategy should be fully embedded in the risk management framework. In that context, special attention should be paid to:
a) ICAAP:(19) all relevant components of the NPE strategy should be fully aligned with and integrated into the ICAAP. Credit institutions should prepare quantitative and qualitative assessments of NPE developments under base and stressed conditions including the impact on capital planning.
b) RAF:(20) RAF and NPE strategies are closely interlinked. In this regard, there should be clearly defined RAF metrics and limits, approved by the management body, that are in alignment with the core elements and targets forming part of the NPE strategy.
c) Recovery plan:(21) where NPE-related indicator levels and actions form part of the recovery plan, credit institutions should ensure that they are in alignment with the NPE strategy targets and operational plan.
Credit institutions should ensure a high level of monitoring and oversight by the risk management functions in respect of the formulation and implementation of the NPE strategy and operational plan.