Address of Governor Dimitar Bogov, at the workshop organized by the NBRM and IFC, for building sustainable NPL management and debt resolution system, Skopje, 28 November 2014
Dear Ladies and Gentlemen, Dear Guests,It is my great pleasure to open this workshop organized with the joint efforts of the National Bank of the Republic of Macedonia and IFC, for building sustainable NPL management and debt resolution system. This topic is certainly of an immense importance for the appropriate functioning of the financial system and banks as its main pillar, especially with the current level of the nonperforming loans. On the other hand, the adequate design of debt resolution tools, insolvency laws and procedures could be viewed as contributing factor for improved access to credit and ultimately should lead to lower cost of financing for businesses. The process of creation of an effective and efficient debt resolution system could not be implemented without involvement of policymakers and regulators, and other relevant authorities. Their role is crucial not only for the design, development and establishment of the system through laws, bylaws and prescribed rules, but also in its accomplishment and effectiveness. I hope that this event, today, will promote open discussion between participants, focused on different aspects of NPL resolution. Let me highlight the importance of this topic for the banking system and some of its broader economic effects.Post-crisis developments in the banking systems of most of European emerging economies clearly demonstrated high growth of nonperforming loans, which was especially obvious in countries with pre-crisis credit boom. In general, Macedonia is not exception from this trend. In the pre-crisis years of strong credit growth, from 2003 to 2008, the average annual growth of banks’ loans was about 28%. During this period, nonperforming loans annually grew by 4% on average. But starting from September 2008, as the month when Lehman Brothers collapsed and financial crisis erupted, until September 2014, the stock of NPLs manifested average annual growth of close to 20%, with corporate sector constituting 85% of this growth. Rapid growth of NPLs after the start of global financial crisis was accompanied with sluggish credit growth. The average annual growth of loans in this period was about 7% (compared to 28% before the crisis). As of September 2014 the share of nonperforming loans in total loans of domestic banks is 12.2%, which is among the lowest levels in the region, but is almost double compared to 6.6% as of September 2008. Many international experts and banking analysts believe that the level of NPLs in Southeastern European countries probably will never return to the pre-crisis level or at least not in the foreseeable future. The specific feature of Macedonian banking system is the persistence of the stock of nonperforming loans. As illustration, more than a quarter of nonperforming loans remain in the banking portfolio longer than 4 years. Also, one half of NPLs are fully provisioned, showing that banks tend to fully cover NPLs with provisions but still to keep them in the books. The other half of nonperforming loans is covered with provisions of about 55%. Banks are not keen to write-off such NPLs, most probably due to the existence of some form of collateral. The cumulative write-offs in the 6 after-crisis years comprise only 5.4% of initial loans balance as of September 2008. Sale of nonperforming loans is almost absent. Persistence of the nonperforming loans in the banking books, usually means lower recovery rates, while waiting for the final decision in the formal bankruptcy or liquidation process usually means longer period for recovery. This situation in Macedonia, actually confirms the findings of several studies that the main problem from the high and growing level of nonperforming loans in emerging countries banking systems is not whether this stock could jeopardize financial stability, but whether the level of these loans could create incentives for banks to reduce flow of new loans to the private sector. Acceleration of the growth of nonperforming loans reduces loan supply through various bank-specific channels and thus, becomes obstacle for achieving sustainable growth rates as one of the main policy challenges in the post crisis years. The recent financial turmoil demonstrated that business failures should be common feature of market economies and that dealing with indebtedness of clients and nonperforming loans is regular part of banking business. However, the differences between the economies are not in the sole existence of the bankruptcies, but in the national frameworks for dealing with insolvent economic agents and available mechanisms for their orderly market exit or business reorganization. The strength of national insolvency framework, including availability of different tools for insolvency workout, are positively correlated with credit conditions and the level of income per capita. This kind of framework should allow protection of creditor rights, which has fundamental importance for the financial system. Practically, developed and effective insolvency regime should enable maximization of the value of insolvent firm’s assets and recoveries of creditor’s claims, with transparency and accountability as its main principles. According to the latest Doing Business Report, stronger insolvency frameworks constitute basis for higher levels of domestic credit provided to the private sector. In Macedonia, starting form 2006, several changes have been made of the national insolvency framework, which according to the latest Doing Business report provide satisfactory strength of insolvency framework. However, building effective and comprehensive legal framework is an on-going process and there is always space for further improvements. For example, the debate is needed whether to introduce personal bankruptcy in Macedonian insolvency framework and if yes, how to adequately align that mechanism with current enforcement law and broad legal framework. Macedonian banks as main creditors in the economy could have more active role in dealing with nonperforming clients. For example, there is a room for more active role of banks in the formal insolvency procedure, especially with creation and approval of reorganization plan for the debtor. In such circumstances, there could be joint cooperation between all creditors, through some form of syndication of their claims. Banks have expertise, knowledge and reputation to promote and lead such process and to monitor the implementation of reorganization plan. If these activities give successful change of the client business, it will bring positive effects for the bank itself, but economic and broader social effects, too. Another possibility for banks is more frequent practicing of informal out-of-court loan restructuring, through interest rate cuts, extension of tenure, applying grace period, interest capitalization, accepting new collateral, currency transformation, debt-equity swap, their combination or any other change of loan terms that will improve debtor payment capability. The key precondition for effective restructuring is banks to have internal procedures and skills that will allow extensive oversight and scrutiny of their portfolio. The objective is timely identification of problematic loans, i.e. in early stages, but not after they become non-performing. Through close cooperation with the client, this would create greater chances for normalizing payment structure of the loan, as well as greater flexibility in negotiation. In Macedonia, the share of restructured loans in total loans is 6.7%. Having in mind higher growth rate of nonperforming loans in after crisis period, there is a room for banks to increase the use of this tool in parallel with improved self-discipline in monitoring and reporting of problematic loans. The banks could consider the sale of nonperforming loans or foreclosed assets to third parties, as a legitimate option for disposal of distressed assets. Benefits could be multidimensional for banks, starting from boosting their loan quality, improving capital position, cost-saving related with collection process, funds raising, etc. Therefore, the banks could deliberate the necessary steps to bring this well-known international practice in the local or regional market. Unfortunately, there is no one-fits-all model for asset management and unique features of local market are decisive element for the sale of nonperforming loans. In Macedonian circumstances, one possible option would be establishment of asset management companies specialized for dealing with nonperforming assets. These companies would be kind of warehouse for selected pools of nonperforming loans, with objective to make the distressed assets attractive to potential buyers. Asset management companies may be established in different ways, through private-public partnership, through some other form of business combination between banks and private entrepreneurs or through joint venture solely of the banks. No matter of their type, they should be independent entities, with their own management and business objectives, and banks would make outright sale of nonperforming loans to them on arm’s length principle. At the initiation these companies might be supported or sponsored by international financial institutions. Relevant option would also be to attract foreign companies or foreign funds to enter the market. Important precondition for creation of the market for nonperforming loans is the determination of NPLs fair value. Crucial element for this is the efficient appraisal methodology for NPLs as well as their collateral. The fair value should reflect the expected recovery rates and should serve as the initial signal for the prices in transactions with nonperforming loans. It might be expected that only with accurate valuation, potential market for NPLs could be developed and potential investors would have interest to invest in such assets. The rationale would be the same in the establishment and operation of asset management companies specialized for buying and selling bank’s foreclosed assets. More intense practicing of any of fore mentioned options will amplify banks’ flexibility of the NPLs management process. This should lead to increase of bank’s recoveries from nonperforming portfolio, but will also have positive impact on numerous other aspects of their business – capital management, liquidity, profitability, risk management etc. To conclude, improvement of credit risk management is continuous and ongoing process, especially in small and open emerging economies, as Macedonia. In this context, debt resolution would be subject of changes and this workshop may provide value added for the participants, opening new ideas and directions for future work in this area, for regulators as well as for representatives of the banking industry. Interactive and fruitful discussion is welcomed.Thank you for your attention.
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