The term Non-Performing Loans (NPLs) refers to impaired loans granted by lenders and represent exposures to entities unable to wholly or partly fulfil their obligations under the contract due to a worsening of the Their economic and financial situation.
According to various Bank of Italy analyses, what has hit the Italian economy most is the recession and the length of credit recovery procedures. The problem of impaired loans is a significant but certainly manageable problem and does not represent an emergency that afflicts all lenders.
As the Governor of the Bank of Italy said in the recent final considerations, this is a generally overstated phenomenon that needs to be properly framed.
Impaired Loans Criteria
To define impaired loans, it is necessary to consider the criteria published in 2013 by the European Banking Authority (EBA) that have been adopted by the Bank of Italy and harmonized at the level of the Single Supervisory Authority (SSM).
In particular, it is possible to further subdivide impaired loans into three sub-groups deriving from more severe situations: non-performing, probable defaults and overdue and/or overdue exposures.
Analysing in detail the three different categories it is possible to define the sufferings as exposures to insolvent subjects or in substantially comparable situations.
Probable defaults are exposures for which the bank considers unlikely that the debtor will fully comply with its contractual obligations without resorting to actions such as collateral security.
Expired and/or overdue exposures can be defined as exposures that have expired or exceeded the limits of reliance for more than 90 days and beyond a predefined threshold of relevance.
In December 2016, NPLs amounted to €173 bn and were subdivided into non-performing loans of €81bn, probable defaults of €85bn and expired and/or overdue exposures of €7bn.
Between 2008 and 2014, there was a double recession that had a significant impact on the balance sheets of Italian banks, and in particular on the quality of their loans.
Recession in Italy
The considerable amount of impaired loans is the result of an exceptional recession that has hit the Italian economy in recent years and procedures for recovering bad debts.
In analysing the Italian banking system, it is evident that the recession caused by US subprime mortgages and structured finance products did not affect the financial system as the banks in the territory were under-exposed.
What has been significant has been the general deterioration of the client’s economic and financial situation, which has led to a significant increase in the rate of formation of new impaired loans and their consistency in the balance sheets of banks.
Sovereign Debt Crisis
Following the sovereign debt crisis in 2011, the client’s ability to repay debt has further reduced, resulting in a further increase in the rate of formation of new impaired loans and an increase in their consistency.
Finally, there was a negative relationship between credit growth and impaired loans between 2008 and 2015. This was mainly due to changes in the economic and financial conditions of the companies and the contraction in their demand for credit.
For lenders, the high stock of impaired loans has adverse effects on their financial statements as it tends to reduce revenue and raise the cost of the collection.
Consequently, the emphasis placed at international level on the subject, while being excessive, is not entirely unjustified, and is, in any case, a fact which cannot be considered pragmatically.
Fivefold Increase in Bad Debts
Between 2007 and 2016, the increase in bad debts recorded by significant intermediaries was on average more than 500% and was particularly high among the most virtuous intermediaries. In other words, the increase in consistency has affected almost all the intermediaries with a traditional business model.
Similar considerations can be made even if the analysis was carried out with reference to the trend of the relationship between the total of impaired loans and the loans to customers.
Analysing the situation at the start of the weaker banks’ crisis, i.e. with a ratio of gross impaired loans to total loans below average, it can be seen that they recorded data between two and three percentage points. The weaker ones, that is, with a higher than average ratio, stood at around seven percentage points.
High Non-Performing Loan Ratio
This report has peaked for the least of the weaker between 2014 and 2015, standing at 15-17%. For the latter, it has exceeded 35% between 2015 and 2016.
What can explain this latter negative is the shortcomings in credit policies and management practices.
Nevertheless, one should not overlook the effect that led to the contraction of assets in the evolution of these indicators. Harvesting capacity on markets has dropped dramatically due to the crisis of confidence.
In Italy, the time needed to close a bankruptcy is twice the average of other European countries, and this has compounded the effects of the economic crisis and the mismanagement practices of some banks.
If the time of civil justice had been in equal to the average European average, Italian banks would have a ratio between abnormal claims and jobs similar to the average recorded in European territory.
In other words, the problems related to the procedures accentuate during periods of economic recession.
Dealing with Impaired Loans
During the phases of strong growth in impaired loans, it is necessary to strengthen the courts, increase the number of magistrates and change the working methodologies.
If the characteristics and number of these organisms remain unchanged, the number of recovery procedures that will be possible to close in one year will be more or less constant. However, regardless of its causes, they are pushing it on the agenda at the European level.
This problem is daunting and difficult to understand to an outside observer because no measures have been taken to deal with it definitively. Recent steps taken by the government are helping to improve the situation, but are not a definitive solution.
So far it has to be said that the growth of abnormal games was also favoured by the modus operandi and the organisational behaviour of lenders who underestimated the complexity of the credit recovery process.