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Alternative approaches to NPLs resolution. Case studies

Author

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  • Faidon Kalfaoglou

    (Bank of Greece)

Abstract

Banks around the globe are struggling with high levels of non-performing loans (NPLs), which prompted several governments to intervene in order to safeguard banking systems, protect deposits and restore normality in financial intermediation. There are two alternative approaches to the resolution of NPLs, i.e. the “off-balance sheet” approach, whereby the distressed elements are transferred off the bank’s balance sheet, usually to an asset management company (bad bank), which potentially has the means to combine specialised resources and expertise to actively manage the portfolio, and the “on-balance sheet” approach whereby the distressed elements are isolated but remain on the balance sheet of the bank, where they are managed by an internal work-out unit or a special purpose subsidiary. Whether an on- or off-balance sheet approach is adopted, the legacy assets remain within the system and an ineffective resolution policy can accumulate imbalances. The international literature and experience shows that there is no single optimal solution but a combination of solutions which depend on the economic and political environment, the intensity of the problem and its root causes. Removing NPLs from bank balance sheets contributes to the rehabilitation of bank financial activities but several challenges should be met, such as the mandate of the bad bank, the ownership, the asset valuation, the financing and the cost sharing, all of which have profound effects on financial stability. The bad bank may exploit economies of scale, but transparency and accountability are two important elements that greatly determine the outcome of the approach. On the other hand, if an internal work-out solution is chosen, it has the advantage of continuity of banking relationships but it is questionable whether true independence in handling the NPLs is possible since the portfolio originated within the bank. The most important challenge is that the approach requires a change in the bank’s business model since loans underwriting and loans resolution requires different skills and culture. The paper reviews the two approaches and analyses international cases, enablinguseful policy conclusions to be drawn.

Suggested Citation

  • Faidon Kalfaoglou, 2015. "Alternative approaches to NPLs resolution. Case studies," Economic Bulletin, Bank of Greece, issue 41, pages 45-70, July.
    • Handle: RePEc:bog:econbl:y:2015:i:40:p:45
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    More about this item

    Keywords

    NPLs; NPLs resolution; bad bank; internal work-outs;
    All these keywords.

    JEL classification:

    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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