1. Loan classification and provisioning – Overview paper of current practices in 26 countries
Katia D’Hulster

2. Objectives Overview paper objectives NPL definition comparison
Interactions with IFRS
Good practice and further work

3. General overview Countries covered in the overview paper
Host countries: Albania, Bosnia Herzegovina, Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Georgia, Kosovo, Latvia, Lithuania, Macedonia, Montenegro, Poland, Romania, Serbia, Slovakia, Slovenia
Home countries: Austria, Denmark, France, Germany, Italy, Greece, Norway and Sweden

4. General comments Basis for classification World Bank survey 2011-2012
Desk review of regulation
Expert judgment where needed
Comments and suggestions on individual country classifications welcome

5. I. NPL definition comparison

6. NPL definition comparison
“..payment of principal and interest past due for more than 90 days”
“..interest payments equal to 90 days interest or more have been capitalized, refinanced or rolled over..”
“…in addition, NPLs should also include those loans with payments less than 90 days past due that are recognized as non performing under the national supervisory guidance. That is, evidence exists to classify a loan as non performing even in the absence of the 90 days past due …”
Source: Financial Soundness Indicators: Compilation Guide

7. I. NPL definition comparison
Dimensions analyzed
Asset classification systems
Defining non performing loans
Loan forbearance
Multiple loans to a single borrower
Collateral valuation
Write offs
Other dimensions
Exposure measurement …

8. 1. Asset classification systems
The majority of the 26 countries in the survey have an asset classification system
Government exposures are generally included in the asset classification system
Of those that have an asset classification system, 72 % have a system that covers government exposures.

9. 1. Asset classification systems
Asset classification systems are more common in host countries
14 out of the 18 countries in the survey have an asset classification system, while only 4 out of the 7 home countries have one.

10. 2. Defining non performing loans
Generally: five buckets and worst three buckets: substandard, doubtful and loss are generally NPL …but difficult to draw conclusions 90 days past due or unlikely to pay Unlikely to pay, with or without realization of collateral? Materiality thresholds, grace periods… Very little guidance on exit criteria

11. 2. Defining non performing loans

12. 3. Loan forbearance Generally referred to as “restructuring”
Wide variety in the definitions
Generally 2 components: change in contract terms and financial difficulty of the borrower
“Embedded” forbearance clauses
Sometimes reduction in cash flows or loss required
Forborne loans not always non performing loans

13. 3. Loan forbearance Review of credit worthiness
45% of the surveyed countries require a review of the credit worthiness of the borrower before it can be upgraded to performing exposures.

14. 3. Loan forbearance Host countries are stricter than home countries
10 host countries out of 15 do not allow immediate upgrade while 2 out of 4 home countries allow immediate upgrade after forbearance.

15. 4. Multiple loans to a single borrower
EBA position on product vs customer view
The EBA proposes to assess NPL exposures on an individual basis (transaction approach), or when more than 20% of the retail borrower’s total exposure is non performing, based on the debtor’s approach.

16. 5. Collateral valuation

17. 4. Collateral valuation
Some countries allow exposure upgrades because of the existence of good quality collateral
e.g. 120 days past due can be upgraded into 90 days past due because of prime collateral.
Other countries allow split of exposure into collateralized part and uncollateralized part
e.g. collateralized part: substandard
uncollateralized part: doubtful

18. 6. Write offs Good practice for write offs
It is good practice to require the Board to review the NPL portfolio every 6 months and to decide if exposures need to be written off.
Requiring prompt write offs of fully provided and uncollectable loans is an area where prudential supervisors and tax authorities can provide the right incentives to banks.

19. II. Prudential impact of IFRS implementation

20. Prudential impact of IFRS implementation
Basel: Expected and unexpected losses
Basel vs IFRS
Provisioning
Accrued interest
Other issues when transitioning

21. 1. Expected and unexpected losses

22. 1. Expected and unexpected losses

23. Basel - Expected Losses
2. Basel vs IFRS
Basel - Expected Losses
IAS 39 - Incurred losses
Anticipated
Forward looking
Trigger event
Objective evidence of impairment
One year horizon
Lifetime of the loan
Averages of the economic cycle
Or stressed conditions
Current economic conditions
Definition of “default” is generally 90 days past due (Basel II para 452 and 453)
Breach of contract
Economic loss
Carrying value of loan minus PV of cash flow discounted at effective rate
Exposure at default includes future draws
Exposure is balance sheet amount

24. Expected losses and incurred losses - overlaps
2. Basel vs IFRS
Expected losses and incurred losses - overlaps
Expert judgment layer
Historical data
Segmentation

25. 2. Basel vs IFRS
IFRS 9 from 2018 Stage 1: 12 months ECL Stage 2: lifetime ECL Stage 3: lifetime ECL Relative assessment of risk Rebuttable assumption of default at 90d past due

26. 3. Provisioning

27. 3. Provisioning

28. 3. Provisioning

29. 4. Accrued interest

30. Other issues when transitioning to IFRS
How to deal with the “excess” regulatory provisions when starting IFRS?
Asset classification systems generally compliant with IFRS
..but regulatory provisioning may have to be revisited
Adjust using capital ratio (Pillar 2) or implement regulatory provisioning by retained earnings when under-provided

31. III. Good practices and areas for further work

32. Some good practices for supervisors
Include government exposures in asset classification and provisioning framework
Require banks to clearly flag and report forborne loans, including keeping track of the number of forbearances for each loan
Report non performing loans using the gross value of the loan, not amount overdue, the value net of provisions or collateral
Include maturity extensions and embedded forbearance clauses in the regulatory definitions of forbearance

33. Some good practices for supervisors
Perform in depth assessment of bank’s statistical provisioning methodologies and, where applicable, understand the differences with the risk inputs used for the regulatory capital calculation
Include clear qualitative criteria in the definition of default
Define clear criteria for regulatory provisions, not just minimum percentages
Consider incentives to establish prompt write offs of fully provided and uncollectable loans …

34. Areas for future work
Deeper understanding Regional cooperation Sharing of knowledge Regional data collection and benchmarking

35. ANNEX

36. Accrued interest under IAS 39
IFRS – With discounting effects
A bank extends a two year loan for 100 Euro (1) on 1 January X0. The principal is to be repaid in two equal installments, at 31 December X0 and X01. No commissions are taken at loan origination, thus the contractual interest rate equals the effective interest rate.
At year-end, interest is accrued at 10% (2)

37. Accrued interest under IAS 39
On 1 January X1, the loan is identified as impaired. The book value of the loan at the time of impairment amounts to 110 Euro (100 principal + 10 accrued interest). The bank assesses the recoverable amount of the loan at 66 Euro, to be received on 31 December X1. The present value of the recoverable amount is 60 Euro (66/(1+10%)=60). The provision to be created is 50 Euro (3)(110 – 60 Euro).
At the end of the second year, the interest accrued is 10% on the net book value of the loan principal, which is now 6 (60x10%).

38. Accrued interest under IAS 39
No discounting effects
A bank extends a two year loan for 100 Euro (1) on 1 January X0. The principal is to be repaid in two equal installments, on 31 December X0 and X1.
At year-end, interest is accrued at 10% (2)

39. Accrued interest under IAS 39
On 1 January X1, the loan is identified as impaired. The book value of the loan at the time of impairment amounted to 110Euro (100 principal+10 accrued interest). The bank assesses the recoverable amount of the loan at 66 Euro, to be received on 31 December X1. The provision to be created is 44Euro (3)(110–66 Euro).
On 31 December X1, the interest accrued is 10% on the net book value of the loan principal, which is now 6.6 (66X10%).
Regulatory adjustment is required: = 34
This is exactly the result IAS 39 gave, without regulatory adjustment.