Friday, August 16, 2013

EU trying to harmonize definition of non-performing loan

Reuters reports that for the ECB's bank asset quality review test the EU is attempting to come up with one definition of what is a non-performing loan.

It is not surprising that there are several definitions of non-performing loans.

Since the beginning of the financial crisis bank, regulators have engaged in regulatory forbearance.  Under regulatory forbearance, banks are allowed to engage in 'extend and pretend' to turn non-performing loans into 'zombie' loans.

Naturally, each bank is going to engage in extend and pretend in a way that minimizes the non-performing loans on and off their balance sheets.

The current attempt to harmonize the definition of non-performing loans confirms what your humble blogger has said about the results of the bank regulator run stress tests as being meaningless.

The current attempt to harmonize the definition of non-performing loans also confirms what your humble blogger has been saying about the importance of requiring banks to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

With ultra transparency, regulatory forbearance and extend and pretend is ended.  Markets will exert discipline by rewarding banks that clean up their bad debt exposures.

Banks across the European Union will be asked to use a single definition for bad loans in the upcoming review of their loan books, a senior EU regulatory source told Reuters, making it harder for banks to conceal the state of their businesses behind local conventions.... 
A senior EBA source told Reuters a key feature of the asset quality review will be harmonizing the way banks categorize loans. EU supervisors use a host of different ways to classify troubled or non performing loans, making it difficult to compare across jurisdictions.... 
The 2011 version of the stress tests, which relied entirely on national supervisors' submissions and definitions, was widely criticized for finding that Europe's 70 largest banks collectively needed just 106 billion euros ($140.62 billion). 
The EBA is keen to ensure this round of stress tests has more credibility, and sees consistency of definitions and transparency of information as a key way of ensuring this.

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