The State-of-the-Art of NPLs in the Post COVID World: An Ongoing Concern for the Future

Abstract

The purpose of this article is to examine the current situation of non-performing loans (NPLs) in the EU from a diachronic perspective, with a special focus on the regulatory and factual events relating to the Covid-19 pandemic. Although we agree with Cicero that "Historia vero testis temporum, lux veritatis, vita memoriae, magistra vitae, nuntia vetustatis", our reflections on the status of NPLs in Europe are necessarily more nuanced. History can serve as a powerful guide, but the greatest disruptive scenarios require a conscious and consistent adjustment by people and regulations. Specifically, they must seek to cope with unforeseen developments that differ from those faced in the past, requiring continued awareness and flexibility. To this end, it is necessary to proceed step by step and begin with a thorough review of the rationale and goals of NPL-related measures taken so far. First of all, it is necessary to examine and recall the critical role played by banks in the economy and how they are able to absorb losses up to a certain amount. It is equally important to note that they cannot cope with heavy losses, which often occur in situations where their ability to lend credit and their reputation on the market cannot shield them from the impact of both pathological NPL flows and the inadequacy of their NPL management structures. Meanwhile, it should also be recalled that the cause of the most recent NPL crisis was linked to the sub-prime crisis, which taught us that the hardest risk to foresee is the probability of default even by normally well-paying debtors. The current situation faced by EU Member States is filled with yet more uncertainty, but we are far better prepared now than we were then. The post-Covid era will benefit from the many safeguards which have already been implemented, including: the prohibition of profit distribution by banks recommended by the EBA; greater flexibility in the interpretation of financial statement criteria (IFRS) and the classification of NPLs; and some essential measures to streamline the functioning of the secondary market for selling or restructuring NPLs. Against this background, empirical evidence can show us which direction we are moving in. It shows that we should not to drop our guard, but rather keep a watchful eye on the situation and act promptly and swiftly if/when needed. More precisely, following the NPL regulatory framework developed by the EU and several nations in the mid-2010s, NPL ratios and the aggregate amount of NPLs consistently dropped between 2015 and the first quarter of 2021, with the one exception being the first quarter of 2021 which saw a slight uptick in the aggregate number of NPLs. Moreover, corporate and household debt levels across some of the more traditionally problematic financial markets in the EU remain relatively healthy, at least compared to 2013 levels. However, government debt-to-GDP levels have increased substantially (almost doubled) in 2020 compared to the mid-2000s and are at their highest ever recorded levels across Member States. This may limit Member States’ capacity to intervene in the event of a financial or economic crisis. We do not say this to cause alarm, but rather present it as a warning to keep alertness levels high and interest in the topic alive. It is anything but outdated, and anything but solvable, with the helpful although rather rudimentary tools that history itself has provided.