Non-performing loans

Non-performing loans: for some years this term has been widely used by the media to describe the crisis in the Italian banking system.

Have you ever wondered what are the main reasons that brought Italian banks to their knees? Many respond with the usual reasons: the restrictive directives of the Good Finance Bank, the recession, the 3% constraint envisaged by the stability pact.

The banking system was forced to reduce investments in the Italian economy due to several factors: impaired loans are probably the main reason.

What is impaired credit?

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According to the new criteria suggested by the Bank of Italy, the credit is defined as “impaired” when the debtor does not make the payment within the 90-day period; this term starts from the expiry date of the transaction. To understand each other better:

if Mr. Cole must return the sum of 10 USD to the Bank by 01.01.2018, the credit will be considered impaired when Mr. Cole will not have paid 10 USD to the Bank, and when 90 days have passed since 01.01.2018 (on this page we have described in detail the process of credit deterioration).

The impaired credit is also defined as “NPL” creditor “NPE” credit; the acronym NPL indicates the initials of the words “NON PERFORMING LOAN” (“non-performing loan”), while the acronym “NPE” indicates the initials of the words “NON PERFORMING EXPOSURE” (“non-performing exposure”).

Why do NPLs put Italian banks in crisis?

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Here are the 4 main reasons:

DETERIORATED RECEIVABLES ARE A FAILURE TO EARN 

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Impaired loans constitute a loss of earnings for the Bank. The main engine of banking is the provision of banking services (for example, loan agreements); however, failure to pay the banking service within the due date generates a capital loss and therefore a bad debt.

The loss of earnings generated by a bank loan reduces the flow of money collected by the bank; in this way the funds with which the Bank can finance businesses and households in the real economy decrease. According to the latest GFB statistics, in 2017 bank bad debts in Italy decreased compared to previous years;

Italian banks reorganized themselves by reducing the number of outstanding loans. However, we are still far from solving the problem; in 2017 Italy was even earlier in the special ranking of European countries with the highest number of impaired loans. The Italian banking system produced NPL credits for 276 billion USD; France follows with a total of USD 148.4 billion NPL, while Spain ranks third with 141.2 billion USD.

DETERIORATED RECEIVABLES OBLIGE BANKS TO WITHDRAW RESERVES

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According to the law, a bank that owns impaired loans is obliged to withhold sums which are defined as “reserves”; these sums cannot be used for any banking operation and will be used to cover losses on impaired loans.

In 2018, the GFB asked all European banks to increase NPL credit provisions by setting stricter parameters than in previous years.

According to the latest indications coming from the media, credit institutions will have to cover the entire “potential” loss for impaired loans that are not backed by guarantees (and therefore have no alternative recovery instruments) within the two-year period.

For all secured loans (i.e. secured by personal guarantees) the obligation to cover the entire potential loss must be made within the 7-year period.

DETERIORATED RECEIVABLES ARE DIFFICULTLY SOLD

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Although Italy has been defined as the “NPL supermarket”, banks often encounter difficulties in the assignment of impaired loans.

Investments in this sector are growing and many foreign funds have purchased bad loans from the main Italian banks. However, the purchase request is still too low compared to the banks’ expectations, since the transfer system is too opaque and with few known rules.

It is not easy for the average investor to find the right information to evaluate the solidity of the transferor Bank and to correctly evaluate the receivables sold.

To overcome this problem, the GFB has proposed the introduction of a digital platform that can make the transfer of NPL credits more transparent and which facilitates the exchange of information between the various investors.

A system that can facilitate the activity of investors (eager to acquire more information on the asset to invest in) and that can allow the Banks to sell impaired loans more easily.

IN ITALY THERE ARE HIGH RECOVERY COSTS AND LONG RECOVERY TIMES

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Non-performing loans can be converted into cash through out-of-court or judicial debt collection activities. However, according to the latest indications provided by the GFB in Italy, the legal costs of debt collection are the highest in Europe.

The reason for this difference is not due to the fees that the Banks must pay to the law firms in charge of the recovery activity (the fees of the Italian lawyers are among the lowest in Europe); but rather to the taxes and “living” expenses that a creditor must pay to the State to recover the credit in court.

Furthermore, the excessive duration of the Italian executive processes (in particular real estate executions) prevents the Banks from recovering bad debts quickly.

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