EBA issues guidelines on loan origination and monitoring
EBA issues guidelines on loan origination and monitoring
On 29 May 2020, the European Banking Authority (EBA) published its final report on the Guidelines on Loan Origination and Monitoring (the Guidelines). The Guidelines specify the internal governance arrangements for institutions in relation to the granting and monitoring of credit facilities. The main aim of the Guidelines is to prevent performing loans from becoming non-performing loans (NPL) in the future by requiring institutions to have robust loan origination standards in place. The Guidelines cover a wide range of issues including ensuring that institutions have strong standards for credit risk taking and monitoring while also covering AML and consumer protection rules.
The Guidelines align with the EBA's supervisory priorities for 2020 by prioritising balance sheet repair and addressing NPLs and preventing a build-up of future NPLs. This strengthens resilience and addresses the risks associated with NPLs. It is clear that supervisors will be focused on understanding lenders' loan origination practices and processes in future.
The Guidelines cover five main sections:
Internal Governance for Credit Granting and Monitoring
Loan Origination Procedures
Valuation of Immovable and Movable Property
The EBA has also published a short Explanatory note on Guidelines on loan origination and monitoring which highlights that "Creditworthiness assessment is the main element of the European Banking Authority's (EBA's) comprehensive approach to loan origination, bringing together prudential, governance and consumer protection requirements in the EBA Guidelines on loan origination and monitoring".
Protecting consumers and protecting the lender
An institution's failures in regard to loan origination and monitoring could have negative consequences for both the institution and their borrowers, where as a result of the failures, the borrower is unable to meet their contractual requirements according to the loan agreement resulting in a NPL. By ensuring responsible lending from the beginning of a loan, an institution will reduce the risk of a borrower taking out an inappropriate loan and ultimately defaulting on their loan. The Guidelines are approaching the issue of loan origination and monitoring from the joint perspectives of the prudential framework and consumer protection. The credit worthiness assessment should ensure that a borrower's characteristics are taken into account to ensure the product is suitable.
Ireland has a robust body of consumer protection legislation, which is often referred to and relied on by the Central Bank of Ireland. For example, the Consumer Protection Code 2012 sets out 12 General Principles with which a regulated entity must comply. The General Principles have a broad scope and include requirements for the regulated entities to act with due skill, care and diligence in the best interests of customers. More specific to the Guidelines, the Consumer Protection Code includes a principle that regulated entities should not recklessly, negligently or deliberately mislead a customer as to the real or perceived advantages or disadvantages of any product of service, Furthermore, the regulated entity must make full disclosure of all relevant material information, including all charges, in a way that seeks to inform the customer.
When dealing with a consumer, Chapter 5 of the Consumer Protection Code 2012 specifically sets out requirements around knowing the consumer and their suitability and sets out details on carrying out an affordability assessment for consumers. However, the Guidelines note that they go further than a creditworthiness assessment, as they "require institutions to also take account of those interests in the credit risk policies and procedures, credit-granting criteria and the design of the credit products that are offered to consumers".
While the principle of proportionality applies to the application of the Guidelines, the principle is itself interpreted differently according to the specific section of the Guidelines. For example, for the implementation of requirements relating to internal governance, risk management and control, the proportionality principle should be based on a variety of factors including the size, nature and complexity of the institutions.
However, competent authorities and institutions should consider the type, size and complexity of the credit facilities being originated or monitored rather than focusing on the particular institution when conducting the creditworthiness assessment, collateral valuation and credit risk monitoring. This approach makes sense as it is the credit facility rather than the institution that is the focus and to do otherwise could potentially give rise to an unbalanced application of the Guidelines.
The Guidelines specifically call out, in relation to lending to consumers, that institutions and creditors should ensure that the application of the proportionality principle does not impair the objective of consumer protection.
The main body of the Guidelines focuses on loan origination but its aim is to prevent NPLs. It therefore envisages covering the life cycle of a loan, including dealing with the issue of an effective monitoring framework. The framework should ensure that "information regarding their credit risk exposures, borrowers and collateral is relevant and up to date, and that the external reporting is reliable, complete, up to date and timely".
What next for Credit Institutions
The Guidelines come at a time when European regulators have highlighted that as a result of COVID-19, the relief measures put in place will likely cause an overall rise in NPLs and drag on bank profitability. The European Central Bank has stressed the importance of NPL reduction for economic recovery and is mindful of the difficulties experienced in implementing effective NPL measures. Accordingly, the European Regulators have prioritised the design of effective NPL resolution policies for the post-COVID-19 world.
Due to the current COVID-19 pandemic, the EBA has decided to offer a three-phase implementation of the Guidelines in order to allow institutions the time to focus on their operational priorities. The Guidelines will apply to newly originated loans from 30 June 2021 and to existing loans that have been renegotiated from 30 June 2022. The application of full monitoring requirements to the stock of existing loans will apply from 30 June 2024, meaning that institutions will have time to address any possible data gaps and adjust their monitoring frameworks and infrastructure. The EBA also states that it expects competent authorities to exercise their judgment and be pragmatic and proportionate when monitoring the implementation of the Guidelines.
This extended timeline will be welcomed by institutions. Due to the wide scope of the Guidelines and the importance of this issue, however, it will be necessary for institutions to continue work on identifying and addressing any gaps in current policies and procedures. Some of the requirements could require important systemic changes, for example to monitor credit facilities or to take account of the risk based pricing requirements.