NEW EUROPEAN STANDARDS ON MANAGEMENT OF NON- PERFORMING EXPOSURES

Uputstvo Evropskog nadzornog tela za bankarstvo o upravljanju problematičnim i restrukturiranim potraživanjima (koje je u primeni od 30. juna 2019. godine), važan je deo Akcionog plana za snižavanje nivoa problematičnih kredita, donetog u julu 2017. godine od strane Evropskog saveta. Uputstvo sadrži deset poglavlja, od kojih su dva poglavlja specifična jer važe samo za banke Evropske unije koje su naročito pogođene nivoom problematičnih potraživanja. Od takvih banaka se traži donošenje ambiciozne, ali realne NPL strategije, koja treba da bude integralni deo poslovnih procesa na svim organizacionim nivoima u banci.


Introduction
Share of non-performing loans in total loans (i.e. the NPL ratio) as well as the absolute level of non-performing loans in EU banks have had a downward trend during the period 2016-2018; and these are good news (see table 1).
However, one should also take into account the following: a. The NPL ratio in the European Union is higher compared to other developed countries of the world. At the end of 2017 the NPL ratios in the USA and Japan were close to no more than 1% (Magnus et al, 2018); b. The NPL burden is unequally distributed among EU Member States. Namely, in more than 10 countries the NPL ratio is higher than 5%; and it is particularly high in Greece and Cyprus (see chart 1); c. The NPL burden is also unequally distributed among EU banks. On average NPL ratio in small and medium-sized EU banks is higher compared to large and systemically important EU banks (Magnus et al, 2018; KPMG 2019). The above data point to the still present need to implement policies and measures aimed at further decreasing non-performing loans in the European Union.
The EBA (European Banking Authority) Guidelines on management of nonperforming and forborne exposures (hereinafter: the EBA Guidelines) are in force as of 30 June 2019. The EBA Guidelines constitute a significant component of the Action Plan to reduce the level of non-performing loans -that was adopted in July 2017 by the European Council.
The EBA Guidelines comprise 10 sections. The most important sections of the EBA Guidelines will be presented in this paper, and these are the sections 4 through 9. Particularly important are section 4 and section 5 -these two sections apply only to: • Banks with a gross NPL ratio equal to or greater than 5%. The ratio is calculated on consolidated and on unconsolidated levels; • Banks for which competent authorities requested the implementation of sections 4 and 5 (for example, due to high concentration of NPLs in a geographical region, an  The EBA Guidelines give particular significance to the consumer protection considerations and requirements as well as fair treatment of consumers by the banks as creditors. Before the presentation of the EBA Guidelines in this article, one more remark is in order: Non-performing exposure (NPE) is broader term than non-performing loans (NPL): aside from loans, it also comprises other on-balance and off-balance products of a bank as a creditor. However, in practice, these two terms are used interchangeably (Magnus et al, 2018; ECB, 2017). Following the same principle, in this article both terms (NPE and NPL) are also used interchangeably.

Section 4: NPE Strategy
As explained, section 4 applies only to EU banks with a gross NPL ratio equal to or greater than 5%, and EU banks for which competent authorities requested the implementation of section 4 (hereinafter: specified banks). Other EU banks do not implement section 4 of the EBA Guidelines.
Specified banks are supposed to define their NPE strategy. The main four phases in developing of the NPE strategy are the following: • At first, specified banks should assess external conditions and internal capabilities to decrease non-performing exposures. On the one side, specified banks assess if the macroeconomic conditions, circumstances in the financial and real estate market, legal framework and other external factors contribute to the resolution of the high level of non-performing loans. On the other side, specified banks should identify the drivers of their NPLs; evaluate the outcomes of NPL actions taken in the past; assess their operating capacities (related to expertise of their teams, equipment of their teams, level of automation...). Specified banks should also assess the impact of the planned NPL decrease on their capital; • Afterwards the NPE strategy should be developed. Specified banks start by establishing a reasonable long-term NPL level; then they set realistic but ambitious quantitative targets in their NPE strategies: by time horizons (short-term and medium-term), by main portfolios (e.g. exposures to corporate, retail, SME) and by implementation options (e.g. rescheduling, restructuring, court and outof-court enforcement, sale of NPL, writeoff). Specified banks define an operational plan, as a supporting document that more closely defines the concrete measures for implementation of the NPE strategy over a time period from 1 to 3 years; • The implementation of the operational plan is ensured by appropriate policies and procedures; • NPE strategy should be incorporated in business processes at all levels of the organisation. The assessment of external conditions and internal capabilities to decrease non-performing loans is an activity performed at least once a year. Consequently, the NPE strategy and its operational plan are subject to review and possible correction. This emphasizes the importance of a dynamic, instead of a static approach to implementing the NPE strategy and its operational plan.

Section 5: NPE Governance and Operations
Section 5 as well applies only to EU banks with a gross NPL ratio equal to or greater than 5% and EU banks for which competent authorities requested the implementation of section 4 (i.e. specified banks). Other EU banks do not implement section 5 of the EBA Guidelines.
There are four significant parts of this section: • NPL-related steering and decision-making. The Management Board of a specified bank has multiple tasks: (i) it annually approves the NPE strategy and its operational plan and

Sections 6, 7 and 8 of the EBA Guidelines
Contents of the next three sections of the EBA Guidelines can be summarized in several main statements.

Section 6: Forbearance
Forbearance measures are to be applied if they lead to a sustainable performing repayment status of a borrower. Forbearance measures must not be misused to cover the borrower's inability to repay the loan.
The decision on adequate forbearance measures should follow after a suitable bank analysis: the financial analysis of borrower's loan repayment capacity as well as a comparative analysis of alternative workout solutions (i.e. comparison of alternative net present values that are calculated based on realistic and credible input parameters).
It is necessary for banks to monitor the efficiency and effectiveness of implemented forbearance measures. The feedback information about the duration of the decision-making process (efficiency) and the degree of success of the implemented forbearance measures (effectiveness) contributes to evaluate the quality of the NPL reduction process and enhance it. aktiviranja instrumenata obezbeđenja, bez obzira na postojanje bilo kog dospelog iznosa ili trajanja docnje." (ECB 2017, str. 49).
Procena imovine vrši se na osnovu tržišne vrednosti; ukoliko je u pitanju pokretna imovina, treba dodatno voditi računa o periodičnoj proceni likvidnosti i pravnoj proceni izvršenja. Procena imovine koja generiše prihod može da se obavlja na osnovu metode diskontovanja novčanih tokova, ali na prudencijalan način (unoseći kredibilne ulazne parametre Popović K. Novi evropski standardi u upravljanju problematičnim potraživanjima is assessed that the debtor is "unlikely to pay its credit obligations in full without realisation of collateral, regardless of the existence of any past-due amount or of the number of days past due." (ECB 2017, p. 49). However, in case of forborne exposures the NPL status remains valid for at least one year after the granting of the forbearance measure. A forborne exposure can exit the NPL status if regular loan repayments have been made over the one-year cure period and if it is likely that the borrower will continue to regularly repay the loan. A forborne exposure that exited the NPL status should continue to be monitored. The NPL status returns if this exposure becomes more than 30 days past-due or if this exposure is granted a new forbearance measure.
Special cases of forborne exposures that have permanent NPL status are: (i) forborne exposures supported by inadequate repayment plans (inadequate from the aspect of credible assessment of the borrower's loan repayment capacity or of the borrower's degree of cooperation with the bank; if such a repayment plan is construed to cover the borrower's inability to repay the loan...); (ii) forborne exposure that includes contract terms delaying the time for regular loan repayments, so that the NPL classification can be affected (for example, grace period of more than two years...); etc.

Section 8: NPE Impairments and Write-Offs
It is important for a bank to timely recognize the un-collectability of an exposure through loss allowances or write-offs. In this section, the European Bank Authority promotes write-offs of non-performing exposures even before legal actions to recover the debt have been concluded in full -it is because the potential later collection can be booked as extraordinary income. In this respect, the European Banking Authority interprets that written-off exposures are not the same as forgiven exposures. Despite remarks during public consultations (on the proposed EBA Guidelines) that, in certain national legal systems, written-off exposures are indeed the same as forgiven debt, the European Banking Authority remains the promoter of active writeoff practices.
It is recommended for banks to back-test their loss allowances against actual losses, in order to obtain feedback information on the quality of the applied methodologies.

Section 9: Collateral Valuation of Immovable and Movable Property
Within this important section, the main message to the banks is to ensure that their valuations of collateral for NPLs are up-todate, well-grounded and based on independent assessments.
The policy and procedures related to the collateral valuation should be approved and reviewed (at least on an annual basis) by the bank's management body. The policy and procedures should ensure, inter alia, the internal quality assurance, and a dedicated unit should be established for this purpose -a unit whose function is independent from those conducting the initial collateral valuation, as well as loan processing.
Banks should have a panel of qualified appraisers; appraisers may be external or internal. External appraisers should have professional indemnity insurance. In selecting appraisers, a bank should avoid any conflict of interest; in that respect the selected appraisers (as well as their first-degree relatives) should not be connected by interest to the loan approval process, or connected by interest to the borrower, or the buyer/seller of the immovable property subject to appraisal, etc. It is required to rotate the appointed appraiser after two consecutive individual valuations of the same property by the same appraiser.
Competent authorities should define a common threshold for the individual valuations of immovable property. The European Banking authority is not responsible to define the threshold. At the time when the exposure is classified as non-performing, the individual appraisal of underlying immovable property should be done again (if such immovable property is subject to individual evaluation). The collateral appraisal should be updated at least once a year, while an exposure continues to be classified as NPL -regardless if underlying asset represents residential or business real estate.
Collateralized property is appraised on the basis of market value; for the movable property, please note that it is important to periodically u jednačinu). Obavezno je poštovanje međunarodnih, evropskih i nacionalnih standarda pri proceni imovine.
Bankama se preporučuje ex-post testiranje procena vrednosti imovine u odnosu na cene po kojima je imovina prodata, radi dobijanja povratne informacije o kvalitetu primenjenih metoda. assess its liquidity as well as legal enforceability. The appraisal of the income-generating property can be done based on the discounted cash flows, but in a prudential manner (using credible input parameters into formula). It is obligatory to respect applicable international, European and national appraisal standards. It is recommended for banks to back-test their collateral valuations against actual sale prices of collateralized property, in order to obtain feedback information on the quality of the applied methods.

Conclusion
The European Union gives a lot of attention to the importance of NPL reduction. There are multiple objectives that European Banking Authority wanted to achieve by the adopted EBA Guidelines, and particularly: (i) more efficient management of non-performing and forborne exposures; (ii) convergence in supervisory activities related to the nonperforming and forborne exposures; (iii) introduction of NPE strategy in banks particularly affected by the high level of nonperforming loans; (iv) extension of the NPL supervisory activities to all EU banks, etc.