Forbearance
On this provision: 1 EBA Q&A
Credit institutions should use the definitions of forbearance measures and FBEs as stated in Annex V (opens EUR-Lex in a new tab) to Commission Implementing Regulation (EU) No 680/2014 (opens EUR-Lex in a new tab) in their risk management. Forbearance measures should aim to return the borrower to a sustainable performing repayment status, taking into account the amount due and minimising expected losses. When deciding on which steps or forbearance measures to take, credit institutions should take into account the interests of consumers and comply with consumer protection requirements, including those set out in Article 28 (opens EUR-Lex in a new tab) of Directive 2014/17/EU (opens EUR-Lex in a new tab)(32) and in the EBA Guidelines on arrears and foreclosure.(33) Credit institutions should monitor the efficiency and effectiveness of forbearance activities.
This section sets out the key elements of governance and operations in relation to FBEs.
6.1Forbearance measures and their viability
Credit institutions should consider using a combination of different forbearance measures, including both short-term and long-term time horizons in line with the nature and maturity of the credit facilities. Credit institutions should consider the list of possible forbearance measures in Annex 5.
Credit institutions should use forbearance measures with time horizons shorter than two years (one year in the case of project finance and the construction of commercial property) where such measures do not address the resolution of outstanding arrears, unless such measures are combined with forbearance measures that are longer than two years.
Credit institutions should consider forbearance measures with time horizons not greater than two years (and, where appropriate, for other forbearance measures) when the borrower meets the following criteria:
a) The borrower has experienced an identifiable event that has caused temporary liquidity constraints. Evidence of such an event should be demonstrated in a formal manner with clear evidence showing that the borrower’s income will recover fully or mostly in the short term, or on the basis of the credit institution concluding that a long-term forbearance solution was not possible due to temporary financial uncertainty of a general or borrower-specific nature. The form of evidence to be provided for this purpose should be proportionate to the nature, maturity and value of the credit facility in question. b) The borrower had been fulfilling contractual obligations prior to the event.
c) The borrower has clearly demonstrated willingness to cooperate with the credit institution.
The contractual terms for any forbearance measure should ensure that the credit institution has the right to review the agreed forbearance measures if the situation of the borrower improves and more favourable conditions for the credit institution (with regard to the forbearance or the original contractual conditions) can therefore be enforced; to this end, the contract should indicate the specific changes to the forbearance measure to be applied as a consequence of specific improvements in the situation of the borrower. Credit institutions should also consider including strict consequences, such as a requirement for additional collateral, in the contractual terms for borrowers who fail to comply with the forbearance agreement.
6.1.1Viable versus non-viable forbearance
Credit institutions should distinguish between viable forbearance measures contributing to reducing the borrower’s exposure and non-viable forbearance measures.
Credit institutions should consider the following factors when assessing the viability of forbearance measures:
a) The credit institution can demonstrate (based on objectively verifiable evidence) that the borrower can afford the forbearance solution, i.e. full repayment is expected.
b) The resolution of outstanding arrears is fully or mostly addressed and a significant reduction in the borrower’s balance in the medium to long term is expected.
c) In cases where previous forbearance measures have been granted, including any previous forbearance measures considered in the long run, the credit institution should ensure that additional internal controls are implemented to ensure that this subsequent forbearance treatment meets the viability criteria outlined below. These controls should include, at a minimum, that such cases are explicitly brought to the attention of the risk control function ex ante. Furthermore, the explicit approval of the relevant senior decision-making body should be sought.
d) Forbearance measures with a short-term time horizon are applied temporarily and the credit institution is able to demonstrate, based on objectively verifiable evidence, that the borrower has the ability to repay the original or modified amount on a full principal and interest basis commencing from the expiry date of the short-term temporary arrangement.
e) The measure does not result in multiple consecutive forbearance measures having been granted to the same exposure.
The assessment of viability should be based on the financial characteristics of the borrower and the forbearance measure to be granted at that time. The viability assessment should take place irrespective of the source of forbearance. Different sources for forbearance measures are, inter alia, the borrower using a forbearance clause embedded in a contract, bilateral negotiation of forbearance between a borrower and a credit institution and a public forbearance scheme extended to all borrowers in a specific situation.
6.2Sound forbearance processes
6.2.1Forbearance policy
Credit institutions should develop a policy on their forbearance activities. The policy should cover at least:
a) the process and procedures for granting forbearance measures, including responsibilities and decision-making;
b) a description of available forbearance measures, including those embedded in contracts;
c) information requirements for assessing the viability of forbearance measures;
d) documentation of forbearance measures granted;
e) the process and metrics for monitoring the efficiency and effectiveness of forbearance measures.
Credit institutions should regularly review their forbearance policies and options based on the collective monitoring of the performance of different forbearance measures, including the examination of potential causes and instances of re-defaults.
6.2.2Efficiency and effectiveness of forbearance activities
Credit institutions should monitor the quality of forbearance activities to make sure that they are not used to delay an assessment that the exposure is uncollectable. The monitoring should cover forbearance activities relating to both performing and non-performing exposures and differentiate between types of forbearance measures and portfolios.
Credit institutions should measure the efficiency of the process for granting forbearance measures and monitor the duration of the decision-making process and the volumes of forbearance measures at each stage of the granting process.
Credit institutions should monitor effectiveness of forbearance measures granted. This monitoring should measure the degree of success of the forbearance measure and whether the modified contractual obligations of the borrower are met and the exposure is performing. The following metrics by portfolio and by type of forbearance measure should be used: a) Forbearance cure rate and rate of exposure being reclassified as non-performing: credit institutions should conduct a vintage analysis and monitor the behaviour of FBEs from the date of modification to determine the cure rate. This analysis should be conducted separately for cured exposures with and without forbearance measures.
b) Cash collection rate: credit institutions should monitor cash collected from FBEs.
c) Write-off: where granting a forbearance measure leads to a partial write-off, credit institutions should record and monitor these exposures against an approved loss budget. The net present value loss associated with the decision to write off an unrecoverable exposure should be monitored against the cure rate.
Credit institutions should monitor indicators relating to forbearance activities using a meaningful breakdown, which could include the type and duration of arrears, the type of exposure, the probability of recovery, the size of the exposures or the total amount of exposures to the same borrower or group of connected clients, and the number of forbearance solutions applied in the past.
6.2.3Assessing the borrower’s repayment capacity
Before granting any forbearance measures, credit institutions should assess the borrower’s repayment capacity. This should include an adequate assessment of the borrower’s financial situation, based on sufficient information and taking into account relevant factors such as the debt-servicing capacity and overall indebtedness of the borrower or the property/project.
6.2.4Standardised forbearance products and decision trees
Credit institutions should have adequate policies and procedures in place with a range of sustainable and effective solutions for the borrower when granting forbearance. The grouping of exposures into portfolios should be reflected in these policies and procedures, to enable credit institutions to adopt different forbearance measures for different segments of borrowers and tailor measures to them.
Credit institutions should consider developing decision trees and standardised forbearance measures for portfolios of homogeneous borrowers with less complex exposures. Decision trees may help in determining and implementing appropriate and sustainable forbearance strategies for specific portfolios of borrowers in a consistent manner based on approved criteria.
6.2.5Comparison with other NPE workout options
Credit institutions should use a net present value approach to determine the most suitable and sustainable workout option for borrowers’ varied circumstances, having regard to the fair treatment of the consumer, and should compare the net present value of the envisaged forbearance measure with the net present value of repossession and other available liquidation options. The parameters used in the calculation, such as the assumed liquidation time horizon, discount rate, cost of capital and liquidation cost, should be based on observed empirical data.
6.2.6Forbearance targets and monitoring
Forbearance contracts and documentation should include a well-defined borrower target schedule, detailing all necessary targets to be achieved by the borrower in order to repay the exposure over the course of the contract term. These milestones/targets should be credible, be appropriately conservative and take account of any potential deterioration in the borrower’s financial situation. The performance of the forborne borrower, including the borrower’s compliance with all agreed targets, should be closely monitored by the NPE WU responsible for granting the forbearance, at least for the duration of the probation period.