The proposed EU framework
The European Commission proposed a number of regulatory norms that are aimed at non-performing loans (NPLs) as a threat to the stability of the financial system of the EU and the Banking Union. These measures are in accordance with the European Councils Action Plan that addresses the issues that NPLs can have to the normal functioning of banks and can lead to systemic failures of the single market within the EU.
I. What are NPLs?
Non-performing loans or non-performing loan agreements are generally defined as loan agreements where the borrower has not paid interest instalments for a period of over 90 days or the borrower reveals that the loan is unlikely to be repaid. Non-performing loans constitute the majority of non-performing exposures (NPEs) on the balance sheets of banks, however NPEs are also consisted of other debt instruments.
II. Why are NPLs so important for the financial stability of the Banking Union?
The importance of NPLs and the reasons why NPLs deserve special attention can be explained by the fact that the value of non-performing loans in Europe are estimated at 1.1 trillion $ or around nine percent of EU GDP and because a high percentage of over 30% of NPLs on bank portfolios was noticed in several countries of the EU (e.g. Cyprus). NPLs are considered to be one of the reasons for the lower profitability of EU banks. It is beneficial to the economy as a whole if the NPLs on the balance sheets of banks are reduced gradually. One of the main causes for the increase of NPLs in the EU is the reduction in the regulation of financial markets and the advancement of information technologies which resulted in the significant development of credit by financial institutions. Banks that have NPLs on their balance sheets need to commit their resources for servicing them as in the case of other assets, however unlike other assets these do not give any profit. When committing its resources to NPLs a bank limits its capacity to lend to new ventures or established businesses causing potential problems to the real economy. Therefore, NPLs have negative effects on banks which in turn have negative impacts on the real economy.
The proposed solution for NPLs in the EU
I. The detected problems
The internal legal framework of the member states of the EU varies, albeit harmonized to a certain extent. Due to this, the legal possibilities that the banks have when managing NPLs depend on the countries of their incorporation and on the applicable laws that govern their loans. Thanks to the recently implemented legal frameworks that pressures banks to free up their capital, the banks in Europe have sold their non-performing loans with large discounts. Another important question is the complexity and duration of the enforcement of loans and the role of the state in the enforcement stage. Seizing collateral in the EU currently can span from 24 hours up to ten years as showed by the research of KPMG.
II. The state-of-play of the European Commission NPL package
According to the Councils Action Plan the European Commission in March 2018 adopted a package of measures that address the issues of NPLs in the EU. The package of measures comprehensively identifies three key standpoints for tackling NPLs. Firstly, by amending the current Capital Requirements Regulation for banks which will constitute new common minimum levels of money for the banks to keep in order to cover future losses caused by loans that turn into NPLs, secondly, a Directive was proposed on the recovery of collateral, credit servicers and credit purchasers and lastly a non-binding guidance on how to set up domestic Asset Management Companies.
A. Amending the current Capital Requirements Regulation for banks
The need of having capital that the bank can draw on when facing problems is aparent. The Commission’s proposal is that banks should establish a common minimum level that banks need to keep in order to cover losses that could arise from future loans that become non-performing which will act as a statutory prudential backstop. The rationale behind prudential backstops is preventing a systemic buildup of NPLs such as at the recent financial crisis. When a loan becomes non-performing i.e. when the borrower does not pay the agreed instalments the bank needs to assume that the loan will not be paid back and set aside more capital. The objective of this framework is for the banks to become more flexible and resistant to adverse shocks by incentivizing them to address NPLs more proactively, preclude them of accumulating NPLs on their balance sheets in the future and facilitating private risk-sharing among the parties while on the other hand decreasing the possibilities of public risk-sharing. The proposed framework will have different coverage requirements depending on the loan itself, with the Councils position distinguishing loans as secured or unsecured and if secured, depending on the collateral as immovable or movable. The maximum loss coverage of a 100% for NPLs secured with immovable collateral will have to be gradually built up for 9 years on the assumption that immovable property retains its value for a longer period of time, while the unsecured NPLs have a significantly shorter period of 3 years for the banks to build up capital to cover these loans, with the maximum coverage requirement of 100% being applied after 3 years. However, a potential drawback could be even though having capital is considered the same as having money, the value of the asset in the banks books can be different from the real value of the asset. All the defined formulas for capital requirements such as Basle I are based on the value of the bank’s assets in the books. The book value can vary to a great extent because it is widely known that the real value of the asset that needs to be sold today “can be worlds apart“ from the assets value in the banks books.
B. The objectives of the Directive on credit servicers, credit purchasers and the recovery of collateral
The objectives that the Commission seeks to accomplish with a Directive on credit servicers, credit purchasers and the recovery of collateral is: a) provide banks with the possibility of efficiently seizing collateral that underpins the loan by facilitating out-of-court collateral enforcement; and b) fostering the development of a secondary market for NPLs by removing barriers to credit servicing and to transfer of NPLs to third parties.
a) Out-of-court collateral enforcement is an efficient way of retaining the value of an NPL by selling assets. However enforcement of collateral was until recently only possible through judicial proceeding, which on the other hand could turn up to be a significantly longer process. This out-of-court regime will not be unlimited at scope. It will only be applicable in cases of out-of-court collateral enforcement in relation to loans granted to businesses and only in cases where the borrower explicitly agreed to it when concluding the loan agreement. Therefore, consumer loans are going to be expressly excluded in this proposed directive. The majority of member states of the EU have implemented legal frameworks allowing out-of-court enforcement of collateral of NPLs. However, in the legal systems of many member states of the EU there needs to be judicial procedures where the loan is secured by real estate. A considerable piece in the total number of collateralized loans, according to the European Banking Coordination Working Group’s 2012 report on NPLs in Central, Eastern and Southeastern European countries, are collateralized by real estate. In the light of these facts the difficulties that are going to follow the objective of out-of-court enforcement of collateral under the proposed directive are apparent. The large number of cases that will be going into out-of-court procedures could pose a threat to personal and property rights of the borrowers unless a solid legal framework is implemented taking into account these threats.
b) A secondary market for NPLs needs to be established in the European Union in order to foster the possibility of transferring loans to third parties across state borders among member states of the EU, but with due regard to consumer protection making sure that their rights and interests are not impacted. Even though there was some progress in recent years, the large numbers of NPLs need to be tackled through further developing secondary markets because the secondary market for distressed debt in the EU is still underdeveloped compared to some third countries. Currently the trade of NPLs is small in volume, there are few active investors in this market and there is a large bid-ask spread. On the other hand, while there are few direct obstacles for the sale of NPLs, the legislation of many member states indirectly restricts trading in NPLs such as with legislation limiting loan transfers only to banks or other financial institutions. The Commission has the goals of removing restrictions to third-party servicing and at the same time harmonizing the basic principles of the servicing of non-performing loans which could be based on having license requirements, providing ruled on trade secrecy and consumer protection. This mechanism will contribute to the further development of the NPL servicing market.
C. Non-binding guidance on how to set up domestic Asset Management Companies
Аsset Management Companies (AMCs) have been used effectively in the past to clean up banking sectors and national financial systems that suffered from a pile up of NPLs. AMCs are familiar in the Eurozone and have been used in countries like Spain or Hungary with some common characteristics such as governments passing legislation that governs them, provided capital and facilitated funding. These AMCs can be established as privately or publicly owned companies, with publicly owned companies dominating the period after the 2007 global economic crisis. In the case that an AMC is established by a member state the question arises whether or not that state is in breach of the European state aid rules. The European Commission, which has the obligation to monitor member states in relation to possible breaches of EU state aid and competition law rules, has adopted an approach that as long as member states act in the same way as private investors there is no breach of EU laws. The EU Commission adopted a comprehensive package of measures in March 2018 among which a technical blueprint for the setting up of national AMCs was published. The technical blueprint provides guidance for the creation and design of national AMCs based on the previous experiences of Member States.
NPLs in Serbia
The banks in the Republic of Serbia have not been immune from the global and EU-wide problems that are generated from a buildup of NPLs. The macroeconomic backgrounds for the NPL accumulation in the bank sheets of Serbian banks are increased unemployment, currency depreciation and higher inflation rates. In June 2015 the Serbian Government rendered its NPL Resolution Strategy with a goal of preventing further accumulation of NPLs to prevent it from impacting banks lending capability and the real economy. One of the central parts of the NPL Resolution Strategy was the further development of the NPL market, which was slowed down by a variety of factors: tax, legal, capacity data and other obstacles. Obstacles that were planned to be tackled were the potential impediments related to the establishment of privately-owned AMCs or other SPVs, and safeguards for the potential liberalization of NPL sale to investors and entities established outside of Serbia. Finally, the National Bank of Serbia (NBS) had conducted a comprehensive analysis of modalities for a potential liberalization of the retail NPL market. The results from the NPL Resolution Strategy are positive. According to the NBS Third quarter report of 2018 Serbia’s Non Performing Loans Ratio stood at 6.4 % in Sep 2018, compared with the ratio of 7.8 % in the previous quarter. Serbia’s Non Performing Loans Ratio data is updated quarterly, available from Sep 2008 to Sep 2018.  The data reached an all-time high of 23.0 % in Sep 2014 before the NPL Resolution Strategy and a record low of 6.4 % in Sep 2018.
The EU banks have a large stock of NPLs on their balance sheets that are gradually being reduced through the adopted measures of EU institutions. Similar efforts are taking place on the domestic level in Serbia. This reduction is not going in the anticipated pace. Although the positive outcomes are visible the high levels of NPLs in some EU Member States still pose a problem. Amelie Labbe, The NPL Clean Up, International Financial Law Review, Vol. 35, Issue 7 (September 2016) 20, page 21, para 1; Juanjo Berdullas, Daniel Gonzales Pila, Alejandra Alvarez Ucar, Lending to lenders, International Financial Law Review, Vol. 35, Issue 3 (April 2016) 64, page 64, para 1  Non-performing loans in the Banking Union, European Parliament Briefing- Stocktaking and challenges, 15th October 2018, available at <http://www.europarl.europa.eu/RegData/etudes/BRIE/2018/614491/IPOL_BRI(2018)614491_EN.pdf > (accessed at 6 June 2019), page 1, para 1
 Guidance to banks on non-performing loans, European Central Bank, March 2017, available at <https://www.bankingsupervision.europa.eu/ecb/pub/pdf/guidance_on_npl.en.pdf > (accessed at 6 June 2019), page 4, para 3
 Christos Gortsos, Platon Monokroussos (Eds), Non-Performing Loans and Resolving Private Sector Insolvency: Experiences from the EU Periphery and the Case of Greece, Palgrave Macmillan 2017 edition, page 47, para 1 Agnes Molnar, Trash or Treasure, International Financial Law Review, Vol. 34, Issue 1 (February 2015) 47, page 47, para 9  Amelie Labbe, The NPL Clean Up, International Financial Law Review, Vol. 35, Issue 7 (September 2016) 20, page 21, para 16  Ibid, page 23, para 2  European Banking Authority Report on Statutory Prudential Backstops, 14th March 2018 available at < https://eba.europa.eu/documents/10180/2087449/EBA+Report+on+Statutory+Prudential+Backstops.pdf > (accessed at 6 June 2019), para 18
 Ibid, executive summary para 3 ; Press release of the Council of the EU on non-performing loans, 31. October
2018, para 3  Press release of the Council of the EU on non-performing loans, 31. October 2018, available at <https://www.consilium.europa.eu/en/press/press-releases/2018/10/31/non-performing-loans-council-approves-position-on-capital-requirements-for-banks-bad-loans/ > (accessed at 6 June 2019), para 7-8
 Paul S. Nadler, Asset-Based Capital requirements: Time for a change, Commercial Lending Review Vol. 6, Issue 4 (Fall 1991) 84, page 86, para 5  Ibid, page 47, para 9  Inception impact assessment for the development of secondary markets for non-performing loans 22. June 2017, European Commission page 1, para 2  Inception impact assessment for the development of secondary markets for non-performing loans 22. June 2017, European Commission page 1, para 2  Inception impact assessment for the development of secondary markets for non-performing loans 22. June 2017, European Commission page 1, para 2  John Fell, Maciej Grodzicki, Reiner Martin, and Edward O’Brien, Role for Systemic Asset Management Companies in Solving Europe’s Non-Performing Loan Problems, European Economy (2017, issue 1), page 73, para 2  Virag Blazcek, A comparative analysis of the bad asset management companies of Spain and Hungary: The devil is in the details, Queen Mary Law Journal Volume 8: Conference Issue London, UK (2016), page 70, para 3  Second Progress Report on the Reduction of Non-Performing Loans in Europe, European Commission, page 11, para 1  NPL Resolution Strategy (“Official Gazette of the Republic of Serbia”, Number 72/15), page 1, para 3  Ibid  National Bank of Serbia, BANKING SECTOR IN SERBIA Third Quarter Report 2018, page 15-20  Ibid  Third Progress Report on the Reduction of Non-Performing Loans in Europe, European Commission, page 12, para 1