7 minute read 3 Mar 2021
Dam water fall on cliff side flowing river

As NPEs increase, how will you control the flow?

By Erberto Viazzo

EY EMEIA Financial Services NPE Leader; Partner, Strategy and Transactions, EY Advisory S.p.A.

Senior corporate finance professional. Extensive track record in financial services and established network of Italian clients.

7 minute read 3 Mar 2021

With asset quality uncertain, strategic management of non-performing loans (NPLs) is key to supporting profitability and customers.

In brief
  • The prolonged economic shock of COVID-19 leaves Europe facing a volatile and deteriorating outlook for asset quality.
  • Banks must act now to preserve the NPL ratios achieved before the pandemic and avoid escalation of distressed debt.
  • The ability to take a strategic, proactive view of non-performing exposures will differentiate banks in the eyes of customers, investors and regulators.

The crisis of 2008 pushed European banks’ non-performing loans to previously unknown levels. Pressure from investors and regulators to reduce this overhang led to the creation of active secondary markets, allowing lenders to sell more than €300bn of non-performing loans over the last decade. Despite this deleveraging, the sector’s NPLs still totaled €636bn in June 2019, with a further €258bn of loans deemed ‘unlikely to pay’1.

The advent of COVID-19 means that banks now face another major credit downturn. The experience of the post-crisis years will be valuable, but today’s circumstances are vastly different. What can banks learn from the past and how should they prepare for the future?

Europe faces an asset quality downturn

Despite the efforts of governments, the credit outlook is deeply uncertain. The credit downturn triggered by COVID-19 is the most challenging Europe has seen since the global financial crisis. It could be the biggest ever - after all, 2020 saw an unprecedented peacetime shock to GDP and a significant increase in unemployment. The pandemic is also doing acute damage to whole sectors of the economy. Industries such as transport, accommodation, entertainment and physical retail are being hit by a simultaneous collapse in demand across multiple markets.

For now, repayment moratoria and public loan guarantees are keeping asset quality in a state of limbo. EU banks have reported €870bn of loans under moratoria, with a further €60bn of loans2 benefiting from other forms of COVID-19 related forbearance. But while these schemes are delaying the pandemic’s impact, they cannot eliminate it. They also create other practical headaches for lenders. As we begin 2021, the greatest sources of uncertainty over asset quality include:

  • Unpredictability over which sectors and sub-sectors may bounce back from the crisis, and which will suffer lasting damage.
  • Complex national and sectoral differences between the precise forms of support businesses and individuals are receiving.
  • The potential for sudden ‘cliff edge’ changes in creditworthiness as support schemes are withdrawn or tapered.
  • The possibility that forbearance could increase eventual credit losses by allowing failing businesses to burn through cash balances.

Underpinning these concerns, Europe faces broader questions over the speed of economic recovery. In particular, it remains to be seen what the long-term effects of unprecedented government borrowing – and perhaps of negative base rates – may be.

Banks confront rising NPLs

The sector will face unprecedented challenges as asset quality worsens. The ongoing downturn in asset quality will inevitably push up European banks’ NPLs. The ECB has estimated that European banks’ stock of non-performing loans could peak at an astonishing €1.4tn3 – higher than in the aftermath of the last global crisis. In addition, altered stress tests, the introduction of a calendar of provisioning and a new definition of default are adding complexity to the challenges facing banks.

The effects of higher NPLs will be felt across Europe, with the bulk of growth likely to occur in the nine key markets that accounted for 85% of European non-performing loans before the pandemic. The extent of the damage will be a function of the size of public support schemes and exposures to the most vulnerable sectors, with greatest impact probably falling in markets where absolute NPLs and average NPL ratios are already high. This group is likely to include markets such as Italy, Spain, Greece, Cyprus and Portugal.

On the upside, many banks in Southern Europe are familiar with heightened levels of non-performing loans and have recent experience of disposals. In contrast, banks in markets with less experience of deleveraging in recent years – such as France, Germany, the UK or the Netherlands – may need to make greater adaptations in response to deteriorating asset quality.

If banks are to support customers and contribute to the recovery, they will need to return their NPL ratios to pre-crisis levels. That will pose significant practical challenges, including:

  • Updating data and analytic tools to better understand customer cohorts, improving segmentation and allowing for targeted sales.
  • Tailoring portfolio analysis and recovery frameworks to the circumstances of retail and small business borrowers, protecting vulnerable customers and monitoring those needing further financial support.
  • Optimizing work outs and collections, planning for an increase in arrears while ensuring fair treatment and protecting vulnerable customers.
  • Revisiting debt sale strategies for non-performing books, identifying solutions by sector and asset class, and taking partial government guarantees into consideration.

An effective NPE strategy is crucial

A holistic strategy will allow banks to develop the capabilities and partnerships they need. Faced with these hurdles, banks need proactive, joined-up non-performing exposure (NPE) strategies that cover every aspect of NPE management and allow for effective prioritization. Strategies must not only cover portfolio review and decisioning, but also the resulting implications for capital ratios and risk-weighted assets, operations, human capital and customers.

As they design their NPE strategies, individual banks can draw on the sector’s experience of deleveraging over the past decade. One key lesson learned was the importance of early recognition for problematic exposures and of early customer engagement. Another was the need for a clear decision-making framework that integrates financial, conduct, operational and capital considerations.

When it comes to disposals, experience shows that in-depth knowledge of the distressed debt ecosystem is vital. That includes understanding typical transaction structures and creating panels of potential investors. Banks should also build dynamic relationships with loan servicers and other specialized service providers, harnessing their capabilities in areas such as valuation, market sounding, due diligence, transaction structuring, tax advice and deal execution.

To implement their NPE strategies, banks will need a range of core capabilities. We have grouped these into five complementary and connected areas as follows:

  1. Customer relationships:
    Understanding changing customer needs, communicating clearly and providing enhanced digital experiences where possible optimizing collections while ensuring fair customer treatment and avoiding harm. 

  2. Portfolio management:
    Building robust management reporting frameworks that quickly triage loans into categories ready for additional financial support, restructuring, work out or disposal. That includes applying reliefs, monitoring eligibility and affordability in real time, identifying covenant breaches and preparing for non-performing loan disposals.

  3. Stress testing and provisioning:
    Analyzing the impact of macro and micro indicators on creditworthiness, modelling economic scenarios, calculating expected credit losses under IFRS 9 and calibrating asset write-downs and impairment charges. 

  4. Operations:
    Preparing people, processes and technology for new conditions and higher workloads. That includes mobilizing and training scaled-up teams, implementing automation where possible, adjusting workforce KPIs and partnering with third-party servicers.

  5. Transforming collection and recovery:
    Using digital technology to transform the efficiency of collections and recoveries. That might involve using decision support to ensure consistent treatment or warning customers with digital EWIs. New technology can be integrated into legacy systems or banks can opt to implement clean end-to-end platforms.

Looking further ahead, banks should think creatively about maintaining customer relationships while optimizing NPL management. That might involve sharing loan restructuring with individual investment funds or securitizing sub-performing loans – which could be made easier by exceptionally low yields. Innovative approaches will help banks respond to industry restructuring and begin pivoting towards a post-COVID world.


Banks that promptly tackle increasing NPEs in an open and efficient manner will emerge from the pandemic-induced downturn in an enhanced position.  The management of distressed debt will need greater care and attention than in the aftermath of previous financial crisis, and will certainly represent a far greater challenge than the industry has seen before. A proactive approach will help banks to allocate more capital to lending, increasing their ability to support customers and avoiding financial penalization. 

About this article

By Erberto Viazzo

EY EMEIA Financial Services NPE Leader; Partner, Strategy and Transactions, EY Advisory S.p.A.

Senior corporate finance professional. Extensive track record in financial services and established network of Italian clients.