Approaching non-performing loans from a macroprudential angle

The emergence and accumulation of non-performing loans (NPLs) on banks' balance sheets is commonly considered a microprudential issue. NPLs come to the attention of macroprudential authorities when they weaken a significant part of the financial system, threatening its stability or impairing one or more of its core functions, such as the provision of credit to the real economy. On a conceptual level, various imperfections may call for policy actions on the management of NPLs. These include unaddressed externalities, economies of scale and coordination failures, institutional distortions (stemming from the accounting, regulatory and tax treatment of NPLs or the judicial and market structures needed for their efficient resolution) and moral hazard vis-à-vis the providers of the banks' safety net. Externalities arise when banks neglect part of the social benefits or costs of actions affecting the origination and management of NPLs when individually deciding on such actions. For example, individual banks and society as a whole may differ in their assessment of the benefits and costs of generating more credit in a boom, with the potential implication of having to cope with a larger NPL problem in a bust (potentially damaging credit supply during the bust and the subsequent recovery). Externalities may be due to the way an unresolved stock of NPLs impairs investors' perceptions of the health of the financial system or prolongs a debt overhang problem, making bank funding more expensive and discouraging banks from taking up new lending opportunities. Other externalities may operate through the impact of the sale of foreclosed assets on prices of similar assets or through a generalisation of forbearance and evergreening strategies damaging banks' reputation as debt collectors and producing a deterioration in borrowers' payment culture. Coordination and collective action problems emerge in the presence of technological or strategic complementarities between agents' decisions. They are conceptually related to externalities and increasing returns to scale. In the absence of a coordinating institution, agents acting in a decentralised manner in their own best interests may become blocked into an inefficient allocation. For example, if creating a secondary market for NPLs requires setup costs that can only be recovered if the volume of trade in such a market is sufficiently large, the economy may be trapped in a situation in which such a market never gets started because it is always too small for the individual agents deciding at the margin whether to establish it. A similar argument has been applied to justify policies promoting the creation of (public and private) asset management companies (AMCs) specialised in buying and managing NPLs.