NON-PERFORMING LOANS (NPLs)

WHAT THEY ARE

Non-performing loans (NPLs) are assets that are no longer able to repay the principal and interest owed to creditors. In practice they are loans whose collection is uncertain both in terms of meeting the due date and as regards the amount of the exposure. In banking language, non-performing loans are also called impaired loans and are divided into various categories, the most important of which are substandard loans (incagli) and bad loans (sofferenze).

The Bank of Italy defines bad loans as loans whose collection is uncertain for the intermediaries that granted the financing because the debtors are in a state of insolvency (even if not established by a court) or in comparable situations. To deal with these kinds of risks, credit intermediaries usually set aside specific reserves in proportion to the at-risk loan and its condition.

The substandard loans represent exposures to borrowers in a situation of objective but temporary difficulty. Unlike bad loans, therefore, substandard loans are loans that are presumed to be recoverable within a reasonable period of time. On a risk scale, substandard loans therefore sit one step below bad loans and consequently require lower provisions in the reserves against risk.

Another type of impaired loan consists of restructured exposures. These are generally exposures that a bank (alone or as part of a pool) modifies by changing the contractual terms and incurring a loss. The change is dictated by a deterioration in the debtor’s financial condition and may result, for example, in a rescheduling of the debt.

Another type of impaired loan consists of past-due and/or overdrawn exposures: these are generally exposures that cannot be classified in the previous categories and have remained unpaid for more than 180 days. For some loans of this type, the supervisory rules set only 90 days as the maximum period.

To monitor risk at the systemic level, the Bank of Italy has created the Central Credit Register (Centrale dei rischi), an archive into which the debt positions of every person towards all intermediaries flow, allowing the overall risk position to be calculated for each debtor and enabling individual intermediaries to check customers’ creditworthiness.

POSSIBLE SOLUTIONS

International hedge funds have set their sights on the NPLs on the balance sheets of Italian banks, and the latter were waiting for nothing else. Indeed, after the stress tests of the European Central Bank (ECB), the urgency is to clean up balance sheets once again, and in an almost lasting way. There are three ways of doing so: consolidating with other players, creating a bad bank into which the worst assets are placed (as the Iberian banks did, editor’s note), or selling packages of impaired assets to third parties. The latter is the path that Italian credit institutions are taking. They sell assets to those who are able to manage them in a more specific way and to those who are able to mitigate any losses on individual portfolios.

The interest of international funds in the NPLs of Italian banks could have an immediate beneficial effect. To address the problems of access to credit for small and medium-sized enterprises in the peripheral euro area, the ECB has launched the Targeted longer-term refinancing operations (TLTROs), and the programme of purchases on the secondary market of covered bonds, asset-backed securities (ABSs) and residential mortgage-backed securities (RMBSs), securitised instruments.

Yet, according to the latest data in the databases of the institution headed by Mario Draghi, the positive effects on the interest rates applied by banks to SMEs, at least in Italy, have not yet been seen. The ECB’s actions are not incisive enough. It is not a matter of systemic liquidity, which is abundant, but of something else. According to the majority of international investors, the blame lies with the mass of substandard loans weighing on the balance sheets of credit institutions. The sooner they decrease, the sooner the taps of liquidity can be reopened, and the sooner businesses will be able to breathe again.