Evolution of the coverage ratio and management of NPLs

June 13, 2017


To start managing the issue of non-performing loans, Italian banks increased their coverage ratio markedly over the past few years. This should enable banks to adopt, as from this year, strategies for reducing non-performing loans both via disposals and via internal management (units specialising in recovery)


The increase in non-performing loans of Italian banks is chiefly the result of the exceptional recession that has hit the country's economy as a consequence of the financial crisis, combined with the lengthy debt recovery procedures. The NPL issue has not yet been overcome although in the past few years considerable steps forward have been made: banks have better protected themselves against the risk of loss and the growth rate of the non-performing loans, bad debts in particular, has decreased. Further positive signs emerge from the data of the first quarter of 2017, which show a drop in doubtful debts (at gross values) compared to December 2016 for most banks. The significant disposal operations scheduled for the current year will contribute to accelerate this trend.

The role of the Supervisory Authorities

Pressure to improve the coverage rates of banks also came from the Supervisory Authorities. In 2012 the Bank of Italy carried out targeted inspections on asset quality, followed by the ECB that, in 2014, on the eve of the launching of the Banking Union, conducted a Comprehensive Assessment (including an Asset Quality Review) on the banks of the Euro area that would start to be under it direct supervision. In 2015, the ECB continued its action, with the institution of a task force on NPLs, also made up of experts of national central banks that, in 2016, published the guidelines for tackling non-performing loans [1].  Coverage policies were carefully reviewed precisely in 2016, in view of the NPL management plans required by the ECB (transmitted towards the end of March 2017) and in preparation of significant transactions for the disposal of non-performing loans announced in the industrial plans of a number of banks.

The coverage ratio improvement

For the aggregate sample of 12 groups [2],  the coverage ratio of non-performing loans thus increased by 11.5 percentage points between 2012 and 2016, with considerable improvement in the course of 2016 (+6 percentage points as compared to 2015), thanks to the increase in provisions and the decrease in gross non-performing loans (Fig.1). In the first quarter of 2017, the coverage ratio further increased compared to December 2016 for many groups, with further coverage adjustments not only for bad debts but also for the other non-performing loans. 

In order to encourage the resolution of the issue of non-performing loans, the legislative authority endorsed several initiatives: the previous penalisation in the tax treatment of loan losses has been dropped and relevant reforms that should speed the recovery of debts have been launched.  

Fig. 1: Coverage ratio, gross non performing loans and stock of provisions from 2012 to 2016 (index – 2012=100)

NPL ratio's targets

In more recent industrial plans and presentations of the financial results in 2016, a few banks have provided some details concerning the NPL ratio targets to be attained by 2019. The objectives meet the guidelines of the ECB and banks should notify their strategy for decreasing non-performing loans in the first quarter of each calendar year, as well as the progress made in the 12 previous months in relation to what was planned. The strategy may include a range of options: in-house management, securitisations, disposals or a combination of the three possibilities. Some bank groups have confirmed that they will set up internal separate and specialised units for the resolution of NPLs, whereas others will rely also on the disposal of non-performing loans, and others have declared they will pursue their objectives via a combination of strategies. 

The scenario: a gradual rise in the cure rate

There is no easy or immediate solution to the problem of non-performing loans: taking NPLs to sustainable levels comparable on a European scale will require time and consistent efforts on the part of banks, as well as the support of the Supervisory authorities, as is already the case.  In our banking sector forecasts, we estimate a gradual rise in the cure rate [3], in step with the consolidation of the economic recovery and with the debt recovery strategies implemented by banks, as well as a significant drop in the probability of default (PD). We carried a simulation on the balance sheets of the 12 national banking groups under a few assumptions on the evolution of the transition matrix (improvement of the PD, danger rate [4] and cure rate in line with our forecasts of the country’s GDP growth rate) that was recently presented at the Banking Day 2017. It shows that the flow of new non-performing loans will be balanced by disposals and internal recoveries, which should bring about a considerable reduction in the stock of non-performing loans between the end of 2016 and 2019. 

[1] “Guidelines for banks on non-performing loans (NPLs)”: a draft of the document subject to public consultation was published in 2016. The final version was published in March 2017.     
[2] Sample composed of the following groups: Unicredit, Intesa SP, MPS, Banco BPM, UBI Banca, Bper, Carige, Credem, BP Sondrio and Credito Valtellinese, Veneto Banca and BP Vicenza.
[3] Probability of recovery from bad debts and of the other non-performing loans.
[4] Probability of transition from “other non-performing loans” to bad debts.
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