The Impact Of Non-performing loans On Financial Stability In The EU Context: Reframing Capital Requirements For Bank Exposure.

Abstract

The present dissertation aims to highlight the important role of proper recording and reporting of NPLs in the bank’s financial documents in order to ensure that the bank’s functioning is not adversely affected. At the same time, there are significant macroeconomic concerns due to which proper and efficient recording of NPLs is required to ensure that regulators can take necessary steps to prevent a bank run which in turn may aggravate an economic crisis. NPLs allow the banks and the regulators to know as to what credit is available for the bank to lend to its customers and therefore, is an indicator of economic and financial stability. If the NPLs increase, the bank has to maintain a much higher level of reserves and is compelled to curtail its lending activities thereby reducing the economic activity as lesser resources are available at the macroeconomic level. Higher NPLs also reduce the bank’s profitability and credibility as it indicates inefficient management and higher risk as it will be unable to lend more and thereby have lesser income as the majority of the bank’s income comes from its lending activities. This has significant impact on the economy and can even transcend national borders given the size of the bank and its resources.The Covid 19 pandemic has aggravated the NPL problem in the EU with estimates that the total volume of NPLs could reach 1.4 trillion Euros by the end of the pandemic. This is alarming and requires active steps to be taken by the European regulators, including the European Central Bank. The regulatory improvements post the global financial crisis and sovereign debt crisis had led to a downward trend in the NPLs but it is possible that the Covid 19 pandemic will cause an increase in NPLs and reverse this downward trend. The use of the secondary market for NPLs played a vital role in rapidly reducing NPLs and in this the use of Asset Management Companies was the most prominent. In these circumstances, it is expected that the EU regulators will further enhance the secondary market for purchase and sale of NPLs and ensure their better regulation to reduce the NPLs on the banks’ balance sheets thereby enhancing financial stability in the region