Last Thursday, the Basel Committee on Banking Supervision (BCBS) published a consultative document on the classification of problem assets, including definitions of nonperforming exposures (NPEs) and forbearance. The lack of a consistent definition of these terms among countries and banks makes bank analysis complex and fuels scepticism of banks’ disclosures. Consistent definitions would aid investors and risk managers in their analysis of banks’ soundness.
The BCBS’ proposed definition of NPE incorporates the following characteristics:
- NPE status applies to all credit exposures, including debt securities
- All exposures to a given counterparty, including uncancellable off-balance-sheet exposures, are classified as an NPE if one transaction is classified as an NPE
- Complementing 90-day past-due criteria with a qualitative assessment of debtors
- Not considering the value of collateral when identifying an NPE
- The ability to upgrade an exposure to performing, contingent on objective criteria
For forbearance, which has no formal international definition, the BCBS recommended a scope identical to the one used with NPEs, with clear identification of forbearance exposures concessionally granted to counterparties facing financial difficulties. The proposal also states that forborne exposures can be either performing or nonperforming, depending on the exposure’s status when the forbearance is extended. Exit from the forborne category would be based on objective criteria, and forbearance status should not result in a reduction in provision requirements.
The need for a single set of guidelines is the result of the BCBS’ assessment of the regulatory frameworks and supervisory practices of 28 jurisdictions. The analysis identified numerous variations, including loan categories based on an accounting layer in eight jurisdictions, on a regulatory layer in 10 countries, and on an ad hoc basis in the remainder. Meanwhile, banks in Asia and the Americas require that exposures classified as nonperforming have six to 12 months of performance before their classification is restored to performing, while in Europe banks are bound by a 12-month time frame. There are also differences in the treatment of collateral and the criteria for income recognition.
An internationally accepted definition of NPE would help improve the identification of such exposures and forbearance and result in more harmonization of banks’ supervisory reporting and public disclosures. A more precise identification of problem loans should force banks to shore up their capital base and reserves. We also expect that specific disclosure requirements in Pillar 3 reports that the BCBS intends to develop will strengthen market discipline. We note that the European Banking Authority’s definition of NPEs and forbearance, published in 2014 before the European Central Bank’s asset quality reviews, prompted some banks in the European Union to significantly increase their provision levels.
The global financial crisis provided evidence that proper categorisation of loans, or lack thereof, has material implications on banks’ provisioning and thus their capital. But for this guidance to be effective, BCBS members would need to fully embrace what would be a voluntary framework. It also remains to be seen whether the BCBS will set a timetable for its implementation and whether the Financial Stability Board would press G-20 members to adopt the framework. Absent these conditions being met, the likelihood of achieving material progress in this area would be slim.
