knowledge 7 August 2020 |

EBA Guidelines on Loan Origination and Monitoring

Background

In July 2017, the Council of Ministers agreed an action plan outlining a mix of policy actions to address the problem of non-performing loans (“NPLs”) in the banking sector. Among other things, the Action Plan called on the EBA to “issue detailed guidelines on banks’ loan origination, monitoring and internal governance which could in particular address issues such as transparency and borrower affordability assessment.”

The new Guidelines are part of a number of measures taken by the EBA to address NPLs, including its ‘Guidelines on management of non-performing and forborne exposures’ and its ‘Guidelines on disclosures of non-performing and forborne exposures’. The EBA has also developed NPL templates. However, in contrast to these measures which address existing NPLs, the Guidelines seek to ensure that institutions put in place appropriate measures to prevent newly originated performing loans from becoming NPLs in the future.

The Guidelines are accompanied by an explanatory note on the EBA’s approach to loan origination and a feedback table containing the EBA’s responses to issues raised in response to its Consultation on the Guidelines, which was published in July 2019.

Overview

At their core, the Guidelines set out the requirements for assessing borrowers’ creditworthiness and for handling the information and data needed for such assessments. They are divided into five main sections, as set out further below, and are supported by three annexes comprising, respectively:

• a set of considerations for credit-granting criteria;
• information and data needs for the purposes of creditworthiness assessment; and
• metrics that can be used in credit-granting and monitoring.

The Guidelines’ implementation is subject to the principle of proportionality, however this principle is interpreted and applied differently for various sections of the Guidelines.

As stated, the Guidelines will apply to loans granted on or after 30 June 2021.  They will also apply to existing loans from 30 June 2022 if the relevant loan’s terms and conditions are changed after 30 June 2021, provided that the changes follow a specific credit decision approval, and their implementation requires a new loan agreement with the borrower or an addendum to an existing agreement.

The EBA previously issued Guidelines which specify creditworthiness assessment for credit agreements with consumers in respect of credit agreements that fall inscope of Article 3 of the Mortgage Credit Directive 2014/17 (the “MCD”). These earlier Guidelines have been incorporated into the new Guidelines and will be repealed once the latter start to apply.

Key sections

Sections 4 – 8 contain the core provisions regarding credit granting and monitoring, which are detailed and comprehensive in scope.

Generally, Section 4 (Internal governance) and Section 8 (Monitoring) apply in relation to all credit risks undertaken by banks and investment firms that fall within the definition of “institutions” set out in the Capital Requirements Regulation 575/2013, excluding debt securities, derivatives and securities financing transactions.

Section 5 (Loan origination procedures) and Section 6 (Pricing) only apply to loans to consumers, micro and small enterprises, and medium-sized and large enterprises.  They do not apply to loans to credit institutions, investment firms, financial institutions, (re)insurance undertakings, and central banks, or loans and advances to sovereigns and public sector entities. Forborne and NPLs are also out of scope.

Section 4: Internal governance

This section sets detailed requirements in relation to institutions’ internal governance for credit granting and monitoring, which apply in addition to those set out in the EBA’s Guidelines on internal governance.

Insofar as credit risk policies and procedures are concerned, the Guidelines include requirements regarding: money laundering and terrorist financing risks associated with the credit granting process; leveraged transactions; the use of technology-enabled innovation for credit-granting; the use of automated models for creditworthiness assessment and credit decision-making; environmental, social and governance (“ESG”) factors; environmentally sustainable lending; and data infrastructure.

Section 5: Loan origination procedures

This section applies to loans made by institutions as well as to loans made by certain creditors within scope of the MCD or the Consumer Credit Directive 2008/48. It specifies:

• the handling and use of documentation, information and data from borrowers for the creditworthiness assessment;
• the assessment of the borrowers’ credit worthiness; and
• requirements for credit decisions and loan agreements.

The applicable requirements differentiate between lending to (i) consumers; (ii) micro and small enterprises; and (iii) small and medium-sized enterprises. They include general requirements as well as asset class/product-specific requirements.

Section 6: Pricing

Section 6 sets out supervisory expectations for the risk-based pricing of loans, listing a set of risk based elements that should be considered and reflected when pricing newly originated loans.  Its objective is to ensure that inscope entities implement a comprehensive framework for loan pricing rather than to prescribe any particular pricing strategies.

Section 7: Valuation

This section provides guidance on the approaches to the valuation of immovable and movable property collateral at the point of credit granting, and the monitoring and review of the value of such collateral, based on the outcome of the monitoring. It applies to any valuation, monitoring and revaluation of immovable property and movable property collateral, excluding financial collateral, conducted after 30 June 2021.

Section 8: Monitoring

Section 8 sets out supervisory requirements for the ongoing monitoring of credit risk and credit exposures, including regular credit reviews of at least medium-sized and large enterprises, the use of management information systems for monitoring and the framework of early warning indicators/watch lists.

If institutions do not have all the required information and data to be used for the monitoring of existing borrowers or credit facilities granted before 21 June 2021, institutions have until 30 June 2024 to collect the missing information and data, through regular credit review of borrowers.

Comment

NPLs have been a significant problem for the EU’s banking sector for some time and the COVID-19 fall out is likely to adversely impact the success of the on-going measures designed to reduce the number of such loans to more manageable levels. In this respect, the Guidelines are to be welcomed to the extent that they contribute to improvements in the credit granting assessment and monitoring process leading to fewer NPLs in the future.

Nevertheless, implementing the Guidelines is likely to have significant implications for at least some institutions’ investment and operational structures, including in particular in the area of IT.  Given the relatively short implementation time-period, such institutions will have a lot to do over the coming months in preparation for 21 June 2021.

On a broader note, the Guidelines reflect many of the recurring themes occupying regulators at both EU and national level. First and foremost among these is the increased focus on consumer protection. While the Guidelines pursue the prudential goal of ensuring inscope entities have robust and prudent lending standards, they simultaneously seek to ensure that the credit-granting practices are aligned with consumer protection rules and respect fair treatment of consumers. 

The Guidelines also highlight regulators’ concern with ensuring the increased efficacy of anti-money laundering and counter terrorist financing controls, the importance of integrating such controls into the business process and using information gathered in day-to-day business activity to inform customer due diligence measures.   Other recurring themes reflected in the Guidelines include automation and ESG/sustainable finance and the importance of ensuring that the regulatory framework remains fit for purpose when it comes to regulating these developing issues.