Menu

Non-performing loans

Credit risk is inherent to the banking business: granting loans always entails the risk that they will not be paid back. For the same reason, credit risk is a focus of the ECB's supervisory work, in which we pay particular attention to non-performing loans (NPLs).

Supervision. Explained.: What are non-performing loans?

The level of non-performing loans is important for the economy as these loans weigh on banks' profitability and absorb valuable resources, restricting banks’ ability to grant new loans. Problems in the banking sector can also quickly spread to other parts of the economy, harming the outlook for jobs and growth. The ECB therefore supports banks in tackling this issue, thereby helping to ensure the safety and soundness of the European banking system.

Non-performing loans are likely to increase

The banks under the ECB’s direct supervision had non-performing loans worth over €550 billion on their books in mid-2020, which represented nearly 3% of their total loan amount. The amount of non-performing loans has steadily decreased from a 2016 peak of around €1 trillion. However, the economic crisis caused by the coronavirus pandemic is likely to trigger a sharp increase in non-performing loans: under a severe but plausible scenario they could reach levels as high as €1.4 trillion by the end of 2022.

The ECB's quarterly supervisory banking statistics provide further details on the level of non-performing loans.

ECB supervisory banking statistics

A supervisory focus

Non-performing loans can have a major impact on a bank’s soundness. ECB supervisors therefore closely monitor the level of non-performing loans across banks. They also check whether banks adequately manage the riskiness of their loans and if they have appropriate strategies, governance structures and processes in place. This is part of the supervisory review and evaluation process (SREP) that is carried out for each bank every year.

Adequate lending standards and credit risk management are key to reducing the risk of loans becoming non-performing and banks piling up bad loans. To minimise this risk, banks should:

  • only lend to customers who are likely to repay
  • monitor loan information to identify distressed borrowers early on and to remedy the situation
  • engage with viable distressed borrowers to restructure their loans
  • book sufficient provisions early enough to ensure proper coverage of losses
  • work to reduce their stock of non-performing loans

Sound lending standards, proper risk management and proactive management of non-performing loans are particularly important in the context of the coronavirus crisis, since payment delinquencies are likely to sharply increase when the measures taken to combat it are withdrawn.

To help banks cope with the crisis and continue lending the ECB has granted them some flexibility, including in the classification of loans to viable borrowers that are only temporarily distressed. But vigilance is required to ensure that this flexibility does not result in support for unviable borrowers and a delay in the classification of their loans as non-performing.

The ECB has provided banks with guidance on how to deal with bad loans, as well as on appropriate provisioning.

A joint effort

In addition to supervisory action, action in two other areas is needed to tackle the high stock of NPLs. The first is legal action: in some European countries, the available legal tools may not be sufficient or may not allow for the timely resolution of bad loans.

The second is action in secondary markets: while banks can use these markets to transfer the risk of holding non-performing loans to non-bank investors, the markets are often underdeveloped. This becomes even more important in the context of the coronavirus crisis and the expected increase in the level of non-performing loans.

The Chair of the ECB Supervisory Board, Andrea Enria, has also suggested that a European asset management company, or a network of asset management companies, could be part of the solution to this issue.

To tackle the issue of non-performing loans at the European level, the Economic and Financial Affairs Council of the EU has set out an action plan in 2017, which includes actions in all three areas: banking supervision, reforms to insolvency and debt recovery frameworks, and the development of secondary markets. The European Commission is monitoring progress in the reduction of non-performing loans. In December 2020 it also presented a strategy to prevent a future build-up of non-performing loans as a result of the coronavirus crisis.