Guidelines on Management of Problem Loans

Developing the NPL Strategy The NPL reduction strategy should layout in a clear, concise manner the bank's approach and objectives (i.e., maximizing recoveries, minimizing losses) as well as establish, at a minimum, annual NPL reduction targets over a realistic but sufficiently ambitious timeframe (minimum 3 years). It also serves as a roadmap for guiding the internal organizational structure, the allocation of internal resources (human capital, information systems, and funding) and the design of proper controls (policies and procedures) to monitor interim performance and take corrective actions to ensure that the overall reduction goals are met. The strategy development process is divided into the following two components: 1. Assessment; and 2. Design. 1. Assessment In order to prepare the NPL strategy, Banks should conduct a comprehensive assessment of their internal operating environment, external climate for resolution, and the impact of various resolution strategies on the bank's capital structure. i. Internal Self-Assessment The purpose of this self-assessment is to provide management with a full understanding of the severity of the problems together with the steps that are to be taken into consideration to correct the situation. Specific details are noted below: a) Internal Operating Assessment: A thorough and realistic self-assessment should be required and performed to determine the severity of the situation and the paces that need to be taken internally to address it, there are a number of key internal aspects that influence the bank's need and ability to optimize its management of, and thus reduce, NPLs and foreclosed assets (where relevant). b) Scale and drivers of the NPL issue: - Size and evolution of its NPL portfolios on an appropriate level of granularity, which requires appropriate portfolio segmentation: - The drivers of NPL in-flows and outflows, by portfolio where relevant; - Other potential correlations and causations. c) Outcomes of NPL actions taken in the past: - Types and nature of actions implemented, including restructuring measures; - The success of the implementation of those activities and related drivers, including the effectiveness of restructuring treatments. d) Operational capacities: Processes, tools, data quality, IT/automation, staff/expertise, decision-making, internal policies, and any other relevant area for the implementation of the strategy) for the different process steps involved, including but not limited to: - early warning and detection/recognition of NPLs; - restructuring; - provisioning; - collateral valuations; - recovery/legal process/foreclosure; - management of foreclosed assets (if relevant); - reporting and monitoring of NPLs and the effectiveness of NPL workout solutions. For each of the process steps involved, including those listed above, banks should perform a thorough self-assessment to determine strengths, significant gaps and any areas of improvement required for them to reach their NPL reduction targets. The resulting internal report should be prepared and the same to be maintained for the record purpose. Banks should monitor and reassess or update relevant aspects of the self-assessment at least annually and regularly seek independent expert views on these aspects, if necessary. ii. Portfolio Segmentation Purpose and principles of portfolio segmentation Segmentation is the process of dividing a large heterogeneous group of Nonperforming loans into smaller more homogeneous parts. It is the essential first step in developing a cost-effective and efficient approach to NPL resolution. Grouping borrowers with similar characteristics allow the bank to develop more focused resolution strategies for each group. Using basic indicators of viability and collateral values, the portfolio can be broken down at an early stage by proposed broad resolution strategies (hold/restructure, dispose, or legal enforcement). Identifying broad asset classes at an early stage of workout is