As Non-performing loans (NPLs) have dropped across Europe, the asset quality of financial institutions has improved. Banks are unquestionably better prepared for hardship than they were in the run-up to the financial crisis of 2008. Still, it may be best to prepare for the worst.

High NPL levels can be a heavy drag on investment, and hence on the economy. Following the launch of the European Commission’s action plan in 2017, NPL levels across Europe dropped significantly. Regulators and supervisors such as the European Banking Authority (EBA) and European Central Bank (ECB) contributed by imposing higher standards on banks’ credit risk management, with special attention to banks’ special asset management operations.

But now, faced with a crisis that may turn out to be much more severe than expected, the question becomes if banks can do more to fend off the consequences of the COVID-19 crisis as those currently low NPL levels are likely to increase. ECB expects it even to rise to unprecedented levels.

The answer to that  question is yes. First off, banks would be wise to adjust their NPL strategies, to have them reflect the changes in the external environment. This means, among other things, increasing capabilities to analyze external dynamics. Special consideration should be given to customer experience and bank reputation, as the majority of obligors in financial difficulties typically recover to become fully performing clients again.

COVID-19 also demonstrates the importance of defining a ‘new reality’ for investing, and highlighting the importance of delivering societal impact beyond financial returns. It is expected environmental, social and governance (ESG) issues will increasingly become central to the economic equation.

Finally, banks have the option to embrace even higher standards. One opportunity is to sign up for the higher standards applicable for high-NPL banks. These require banks to meet the expectations defined in the ECB’s NPL Guidance with respect to strategies, governance and operations.

Combined with a more resilient business model, optimal asset quality provides banks with the best possible starting position to withstand upcoming headwinds, and thrive in a post-COVID-19 world. With all uncertainties surrounding the crisis we should hope for the best, but prepare for the worst.

For more insight on managing asset quality, download our whitepaper by clicking the link below.  In this document, we focus on the implications of these developments on loan origination and management practices for Dutch banks. We present a number considerations for our clients that will help them to define and support the way forward once the worst shock has passed.