The non-performing loans directive is now live

Non-performing loans (NPLs) are mainly loans with payments of interest or capital more than ninety days past due and/or for which the bank considers that the borrower is unlikely to pay its credit obligations.¹

Although the proposed NPL Directive has been under discussion since 2018, the increase in the NPL ratio further exacerbated by the COVID-19 pandemic may have accelerated the legislative process.

In brief

• The NPL Directive works to expedite and regulate the development of a secondary NPL market in Europe through the authorisation and supervision of credit servicers
• Credit servicers will be subject to new requirements when interacting with borrowers. They will also need to put in place specific agreements with credit purchasers and when outsourcing their credit servicing activities to credit service providers
• The transfer of NPLs will trigger disclosure requirements towards the purchaser, notification requirements to the borrower, and reporting to regulators

Secondary NPL market in Europe

The existence and increase of NPLs has been a growing concern for credit institutions for several years. The European Central Bank recently warned that adverse scenarios could put peak NPLs to 1.4 trillion euros by the end of 2022.²

The EU already regulates the issuance and distribution of a wide range of financial products. This new framework creates rules for purchasers and servicers of loans issued by banks and their subsidiaries in the EU, increasing protection and limiting opportunities for shadow banking.

For Luxembourg banks, the NPL Directive may mean more efficient access to cross-border opportunities and a more competitive and transparent NPL marketplace. It is also designed to help banks offload NPLs from their balance sheets and distribute the risk, free up bank resources, and strengthen bank stability. 

Key elements of the NPL Directive

The NPL Directive regulates credit market players and the transfers of credit agreements by establishing a new licensed status for credit servicers.

Supervision of the secondary banking market and new licence for credit servicers

The NPL Directive acknowledges the existence of a secondary market for loans and creates a dedicated framework. Although the definitions may seem a bit confusing at first glance, they can be summarised as follows.

• Credit purchasers acquire NPLs either from banks or from other credit purchasers. For that purpose, they can entrust credit servicers with the handling of these credit agreements.
• Credit servicers offer credit servicing activities and also manage and enforce NPLs.
• Credit servicing activities consist of (i) recovering payments from the borrower, (ii) renegotiating loans, (iii) administering complaints related to loans and (iv) informing borrowers of changes in interest rates or other charges.
• Credit servicers can outsource their credit servicing activities to credit service providers.

The NPL Directive requires that credit servicers first obtain a licence for their activities and sets out the requirements for their authorisation. The authorisation process will be harmonised throughout Member States and credit servicers will benefit from the European passport to operate across the EU. The Host and Home Member States will cooperate and share relevant information to ensure compliance with the NPL Directive and national implementation. They may also impose administrative sanctions, penalties, or remedial measures in the case of non-compliance. Each Member State will also establish a register of authorised credit servicers.

This licensing requirement does not apply to banks, certain professionals performing lending activities, AIFMs, management companies, and certain investment companies authorised under the UCITS Directive, which are outside the scope of application of the NPL Directive. There is a six-month transition period for entities which currently provide credit servicing activities to be authorised as a credit servicer.

Room for interpretation

These definitions leave room for interpretation. Certain market players may determine that their activities do not trigger any licensing requirement. In particular, the distinction between credit servicers and credit service providers may raise discussions when assessing whether a licence is needed or not. The sole difference appears to be the benefit of a European passport and the possibility of enforcing NPLs. It will be interesting to see how the Luxembourg implementing law or the CSSF’s guidance may clarify this.

Once they obtain their licence, credit servicers will need to comply with several conduct of business rules towards borrowers (e.g. avoiding any harassment, coercion or undue influence, acting in good faith, providing clear and truthful information) as well as towards credit purchasers which hire them (e.g. content of management contract, prior notification when relying on credit service providers, recordkeeping).

A new process specific to credit purchasing

Banks will be required to provide all necessary information to credit purchasers to enable them to assess the value of the credit agreement and the likelihood of recovery of value.

In addition, any transfer of NPLs will trigger a notification to the borrower, to be done by the credit purchaser or the credit servicer which is appointed. The NPL Directive details the content of such notification.

Banks must also inform competent authorities about the details of the loans they transferred. The EBA will implement draft technical standards to standardise a format for this type of reporting. A data template is currently under consultation and is planned to be made available in the course of 2022. With the adoption of the NPL Directive, the data template will be included in the implementing technical standards.

Credit purchasers based in the EU are not required to apply for a specific licence. They should however appoint a bank, a professional performing lending activities or a credit servicer for managing NPLs concluded with consumers. With respect to credit purchasers based in a third country, this appointment requirement also applies for NPLs concluded with any natural person and with small and medium enterprises.

Key dates and next steps

Member States have until 29 December 2023 to implement the NPL Directive into national legislation. This leaves two years for the banking industry to assess the impact and opportunities.

Key considerations for banks include:

• establishing relationships with credit servicers;
• conducting due diligence;
• implementing disclosure requirements towards credit purchasers; and
• adjusting reporting processes.

Credit servicers will need to:

• obtain a credit servicer licence and undertake the EU passporting notifications;
• implement new conduct of business rules and notifications towards borrowers;
• prepare compliant credit servicing agreements; and
• prepare compliant outsourcing arrangements with credit service providers.

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^{1 Combined reading of article 47a paragraph 3.a) and article 178 paragraph 1 of Regulation (EU) No 575/2013 of 26 June 2013 on prudential requirements for credit institutions and investment firms, as amended.}

^{2 https://www.bankingsupervision.europa.eu/banking/priorities/npl/html/index.en.html}