Assessing 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.