The European Central Bank (ECB) wants to make the process of reducing non-performing loans (NPL) in banks more flexible and in line with the current reality. The ECB has launched a Next Level Supervision project, as announced in the regular Supervision Spotlight bulletin. According to this year’s plans, the ECB’s expectations for coverage of non-performing exposures will no longer be issued as a recommendation for additional capital requirements for banks during the year. Instead, the ECB will publish an operational act setting out the expected coverage of non-performing exposures for several years.
Banks with insignificant volumes of old overdue exposures falling within the scope of the ECB’s policies will no longer need to set aside coverage for expected NPL or report them – this should serve as an incentive to continue reducing their share. For certain exposures, if the criteria are met, the ECB has already allowed banks to reduce the shortfall related to minimum coverage under expected provisions. Banks often rely on this opportunity by submitting a large volume of applications related to specific conditions at individual banks. Now, the ECB will increase its supervision of banks that have submitted more applications, while the level of checks for others will remain the same. These three specific measures are expected to make the supervisory process more efficient while maintaining the policy for reducing non-performing loans.
The ECB’s experience shows that consistent and strong supervision works, according to the Central Bank. It will also focus more on lending practices, as strong standards for this are key to keeping NPL’s levels low.
The Central Bank explains that addressing NPL has been a top priority since 2014. Following the 2008 global financial crisis and subsequent recession, many borrowers struggled to meet their obligations, and banks in Europe accumulated many non-performing loans. In some countries, weak legal frameworks, poor bank management, and inefficient processes for dealing with problem loans made things even worse. This leads to a dangerous cycle: high NPL levels weigh on bank profits and capital, limiting their ability to lend to households and businesses. This slows down economic activity and leads to even more overdue debt.
The ECB pays attention to all types of non-performing exposures, including loans, debt securities, and off-balance sheet instruments. After publishing guidelines, acts, and requirements for banks, the volume of coverage of expected overdue exposures fell from nearly €500 billion in 2020 to around €180 billion at the end of 2024, according to the Central Bank. Among other supervisory measures, since 2021, the ECB has targeted additional capital requirements for banks that cannot set aside sufficient provisions. From 2021 until last year, the number of banks needing the specific add-on fell from 22 to 9, according to the ECB.
These measures contributed to maintaining an average level of 2.2% non-performing loans over the past three years, which is a significant reduction compared to the previous decade when they were over 7% of portfolios.
