EBA publishes guidelines on loan origination and tracking

On May 29, 2020, the European Banking Authority (TSA) published its final report on Guidelines on origination and monitoring of loans (the Guidelines). The guidelines specify the internal governance arrangements of institutions with regard to the granting and monitoring of credit facilities. The main objective of the guidelines is to prevent performing loans from turning into non-performing loans (NPL) in the future by requiring institutions to put in place strong lending standards. The guidelines cover a wide range of issues, including ensuring that institutions have high standards for taking and monitoring credit risk, while also covering AML and consumer protection rules.

The guidance aligns with the EBA’s prudential priorities for 2020 by prioritizing balance sheet repair and processing of NPLs and preventing the accumulation of future NPLs. This builds resilience and addresses the risks associated with NPLs. Clearly, supervisors will focus in the future on understanding lender loan origination practices and processes.

The Guidelines cover five main sections:

• Internal governance for granting and monitoring loans
• Loan granting procedures
• Price
• Real estate and movable property valuation
• Monitoring framework

The EBA has also published a short explanatory note on the guidelines for the origination and monitoring of loans which underlines that “the assessment of creditworthiness is the main element of the overall approach of the European Banking Authority (EBA ) in terms of loan origination, bringing together prudential, governance and consumer protection requirements in the EBA guidelines on loan origination and monitoring “.

Protect consumers and protect the lender

Failures of an institution in loan origination and monitoring could have negative consequences for both the institution and its borrowers, when due to these failures the borrower is unable to meet its contractual requirements in accordance with the loan agreement resulting in an NPL. By securing a responsible loan from the outset of a loan, an institution will reduce the risk that a borrower will take on an inappropriate loan and ultimately default on their loan. The Guidelines address the issue of loan origination and monitoring from the perspective of the prudential framework and consumer protection. The creditworthiness assessment should ensure that the characteristics of a borrower are taken into account to ensure that the product is suitable.

Ireland has strong consumer protection legislation, which is often relied on and relied upon by the Central Bank of Ireland. For example, the 2012 Consumer Protection Code sets out 12 general principles with which a regulated entity must comply. The General Principles are broad in scope and include requirements for regulated entities to act with due skill, care and diligence in the best interests of clients. Specifically to the Guidelines, the Consumer Protection Code includes a principle that regulated entities must not mislead a customer in a reckless, negligent or deliberate manner as to the real or perceived advantages or disadvantages of any service product. In addition, the regulated entity must make full disclosure of all relevant material information, including all charges, in a manner that seeks to inform the customer.

When it comes to a consumer, Chapter 5 of the Consumer Protection Code 2012 specifically defines the requirements for consumer knowledge and suitability and sets out the details on how to conduct an affordability assessment. for consumers. However, the guidelines note that they go beyond a creditworthiness assessment, as they “require institutions to also take these interests into account in credit risk policies and procedures, credit rating criteria. and the design of consumer credit products. “.

Proportionality

While the principle of proportionality applies to the application of the guidelines, the principle itself is interpreted differently depending on the specific section of the guidelines. For example, for the implementation of internal governance, risk management and control requirements, the principle of proportionality should be based on various factors, including the size, nature and complexity of institutions.

However, competent authorities and institutions should take into account the type, size and complexity of credit facilities put in place or supervised rather than focusing on the particular institution when assessing creditworthiness, the valuation of guarantees and the monitoring of credit risk. This approach makes sense because it is the credit facility rather than the institution that is targeted and doing otherwise could potentially result in an unbalanced application of the Guidelines.

The guidelines specifically require, with regard to consumer loans, that institutions and creditors ensure that the application of the principle of proportionality does not undermine the objective of consumer protection.

Monitoring

The main body of the Guidelines focuses on loan origination, but its purpose is to prevent NPLs. It therefore plans to cover the life cycle of a loan, in particular by addressing the issue of an effective monitoring framework. The framework should ensure that “information about their credit risk exposures, borrowers and collateral is relevant and up-to-date, and that external reports are reliable, complete, up-to-date and timely”.

What future for credit institutions

The guidelines come at a time when European regulators have stressed that in the aftermath of COVID-19, the relief measures put in place will likely lead to an overall increase in NPLs and weigh on bank profitability. The European Central Bank has stressed the importance of reducing NPLs for economic recovery and is aware of the difficulties encountered in implementing effective NPL measures. As a result, European regulators have prioritized designing effective NPL resolution policies for the post-COVID-19 world.

Due to the current COVID-19 pandemic, the EBA has decided to propose a three-phase implementation of the guidelines in order to give facilities time to focus on their operational priorities. The guidelines will apply to newly issued loans from June 30, 2021 and to existing loans that have been renegotiated from June 30, 2022. The application of full monitoring requirements to the stock of existing loans will apply from June 30, 2024, which means institutions will have time to fill any data gaps and adjust their monitoring frameworks and infrastructure. The EBA also states that it expects competent authorities to exercise judgment and be pragmatic and proportionate when monitoring the implementation of the guidelines.

This extended deadline will be welcomed by the institutions. However, due to the broad scope of the Guidelines and the importance of this issue, it will be necessary for institutions to continue to work to identify and address gaps in current policies and procedures. Some of the requirements may require significant systemic changes, for example to monitor credit facilities or to accommodate risk-based pricing requirements.