New capital requirements for non-performing exposures (NPEs)

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The European Parliament has decided to introduce new capital regulations for non-performing exposures (NPEs). The new regulation is applicable for exposures originating after 26th April 2019, and when those exposures possibly meet the criteria’s for NPE. The regulation will change how European credit institutions manage NPEs and will increase the capital requirements and monitoring of NPEs. FCG recommends institutions to assess the impact of the new regulation and take appropriate actions. 

NPL action plan for NPEs

In 2018, European Commission presented an NPL action plan to address the challenges of high NPL ratios in Europe. The action plan includes nine different parts, and the most thorough action is the amended capital requirement regulations for NPE in CRR (Regulation EU No 575/2013) requiring a deduction from own funds where NPEs are not sufficiently covered by provisions or other adjustments. The new regulation intends to create a prudent classification and treatment of NPEs that would apply uniformly to all institutions in the Union.

Principles of prudential backstop

The amended capital regulation for NPE, the so called Prudential Backstop, aims to ensure a minimum coverage level for newly originated loans that become non-performing. The regulation is applicable for all credit institutions in Europe, and for exposures originating after 26th April 2019 aswell as those exposures possibly meeting the criterias for NPE. The regulation introduces the definitions of non-performing exposures (NPE) and forborne exposures (FBE) in CRR. The definitions build on the existing supervisory reporting framework, i.e. FINREP.

The prudential backstop requires a deduction from own funds where NPEs are not sufficiently covered by provisions or other adjustments. The applicable amount of own funds deductions depends mainly on the size of the exposure, the numbers of years the exposure has been classified as NPE, the type and value of collateral and the amount of provisions. The deduction increases for each year the exposure have been classified as non-performing, and after 3-10 years the prudential backstop corresponds a full coverage (see picture below).

The applicable amount of insufficient coverage should be determined separately for each NPE and calculated by using the applicable factor (visualized in graph) multiplied with the amount of NPE. The amount of CET-1 deduction decreases if specific credit risk adjustments or other value adjustments has been assigned.

Assessing the effects and take appropriate actions

FCG recommends institutions to assess how the new regulation will affect the credit risk management and the capital requirement the upcoming years, and decide on appropriate actions.

A credit institution should review the risk strategy, processes and policies for NPE. It is especially important that decision-making bodies has enough information before granting new loans to NPE or FBE. FCG also recommends institutions to review how NPE and FBE should be managed in relation the process of identifying defaulted exposures and the application of accounting standards.

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