Structural challenges still impede optimal non-performing loan resolution, writes Barbara Pianese.

The past few years have seen non-performing loan (NPL) ratios decline across the globe and banks are well capitalised to face bad loans risk. However, slower economic growth could still put pressure on the financial sector. 

Global economic expansion is projected to fall from an estimated 3.4% in 2022 to 2.9% this year, according to the International Monetary Fund. NPLs are negatively correlated with gross domestic product and positively correlated with interest rates.

The global financial crisis had seen a strong uptake in NPLs in banks’ balance sheets. The NPL ratio in Europe reached 7.5% in 2012 and then started to decrease in 2016. Before the coronavirus outbreak, the level of NPLs had fallen substantially in Europe and other regions due to the enhanced loan selling activities of banks in recent years. 

In some countries, risks may be difficult to estimate if only the biggest lenders are taken into account. The dominant players in the Chinese banking system are healthy at present, while smaller players have more exposure to distressed sectors. Slow growth might bring to light China’s potential financial stability risks. 

Banks’ asset quality remained relatively resilient during the Covid-19 pandemic, but there is now growing concern because the increasing likelihood of a recession or slower growth in some countries is expected to solidify those risks. The current volatility could affect defaults and pressure on households and business borrowers. 

Only some European states have deployed multiple targeted support measures that will remain in effect in 2023. The interest rate hikes and the removal of extraordinary borrower support and forbearance during the pandemic will put pressure on NPLs. 

In addition, growing credit spreads between markets will particularly affect debtors in countries that face higher borrowing costs. 

At the same time, rising interest rates might offset some of the impacts of weaker asset quality and higher funding costs.

Regulators are expected to continue pressuring banks to identify signs of borrower stress early and to act on them in a timely manner. In 2020, for example, the European Commission published an action plan for tackling NPLs in the aftermath of the pandemic, highlighting a potential need for banks to move NPLs off their balance sheets.

As suggested in a report by the Asian Development Bank, regulators should adopt a broad and uniform definition of NPLs and non-performing exposures, such as the one from the Basel Committee on Banking Supervision, to capture the widest range of distressed assets. 

A number of factors make NPL resolution challenging, suggests the report. Poor legal frameworks, insufficient judicial capacity and opaque and lengthy collateral enforcement and insolvency proceedings make recoveries in asset values harder and more expensive.



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