Bankers’ alert: Revolutionary quantum leaps in banking

 
True, certain banks are ahead of others on the quest to recovery. True, certain banks have begun to explore more revolutionary ways of harnessing the non-performing loans’ (NPL) beast.
Notwithstanding this, more is needed. These are the revolutionary quantum leaps which banks will have to consider to get them out of the NPL deadlock:

First quantum leap: “We cannot do it all by ourselves”

International practice evidences a number of approaches on handling such situations, along a continuum of structures from in-house NPL management on the one side of the spectrum to outright debt sales on the other extreme of the spectrum.
As already explained, the internal solution is not as effective or quick enough as banks would like it to be, whereas the sale alternative does not appear to be feasible to a significant extent at present. So the solution must be sought somewhere in the middle of the continuum.
Internationally, what a number of banks have sought to do to supplement their internal resources and to ameliorate the NPLs burden, is to outsource the management of certain parts of their portfolios to outside expert managers or debt servicing specialists or, alternatively, to insource these experts into the Bank’s internal organisational set-up, with a view to maximizing capacity and realisation potential.
Expert third-party NPL servicing brings to the fore much needed intensity, aggressiveness and disciplined perseverance to the management of NPLs. At the same time, this strategy also gives banks time to gradually top up their impairment provision reserves, which will facilitate in the future a more forceful management of NPLs through, for example, more aggressive, but at the same time more sustainable, restructuring solutions or a carefully worked-out, capital-balanced sale of debt.
The ECB’s recently published Guidance to Banks on Non-Performing Loans states that “specialised servicers can significantly reduce NPL maintenance and workout costs. However, such servicing agreements need to be well steered and well managed by the bank”.

Second quantum leap: “Bring in an investor”

The appointment of external servicing specialists can either be done via outright direct outsourcing or could go a step further on the continuum via the creation of joint venture vehicles, whereby the management of the loan portfolio is transferred to a new company which is jointly owned, at pre-agreed shareholding percentages, with an investor (in these structures the bank typically holds a non-controlling stake). The joint venture SPV may go the extra mile too, by putting up extra finance to fund certain borrowers’ operations and their streamlining or growth plans.
Although the debt exposure in these structures remains on the bank’s balance sheet, the fact that the management of the loans is undertaken by an entirely different business set-up creates flexibility with regard to the range and the boldness of the solutions offered and frees up management from day-to-day tribulations. Truly far-reaching, and sustainable, solutions may be provided by these structures which wouldn’t be typically offered in conventional banking surroundings.
Such structures have been set up to manage the failed Bradford & Bingley’s mortgage portfolio in the UK, and certain segments of the NPL portfolios of Intesa San Paolo and UniCredit in Italy with the participation in the venture of KKR Credit. The latter has also joined forces with ALPHA Bank and Eurobank in Greece to manage parts of their NPL portfolio too (the European Bank for Reconstruction and Development is also a minority shareholder in this structure).
In its relevant press release, KKR Credit notes that “[forces have been joined] to launch a platform that aims to provide long-term capital and operational expertise to [local] companies, thereby supporting [local] banks in managing their assets. The platform is intended to help [local] companies stabilise, grow and create value for the benefit of all stakeholders, including the companies' existing shareholders and the banks who will share in the upside of the recovery in performance of the businesses and the value of the related assets on their balance sheet. The platform is open to other lenders and companies who would benefit from fresh capital and additional operational support”. Which brings us to the next round of quantum leaps.

Third quantum leap: “Join forces”

Possibly, the only realistic way forward would be for a number of local banks to pull their resources together, gathering, in effect, muscle to face in united stance the NPLs challenge. Power in unison, as it were, instead of fighting this Lernaean Hydra one at a time. Think for example of a ten-handed, as compared to the conventional two-handed, juggler, juggling with the same number of air-borne balls.
Are local banks mature enough to strike up partnerships between themselves to create shared debt servicing platforms? Wouldn’t such a move have sound conceptual grounding? Banks, smaller ones in particular, would be relieved of the unbearable burden on their resources, would benefit from substantial economies of scale in terms of costs, expertise, effectiveness, and would share in the upside and downside of the venture.

Fourth quantum leap: “Create an asset management company”

Going a step further forward, banks may pull up their resources to jointly set up a local AMC. Admittedly, normal practice calls for the state to participate and play a pivotal role in such a venture. Although at present it seems unlikely that the state can or would want to participate in such a venture, for reasons already explained, we cannot rule out this possibility in the future from becoming an obligatory requirement, should progress towards balance sheet cleaning up prove insufficient. We could also of course see a pan-European AMC being set up along the lines described earlier.
A more revolutionary move would, however, entail local banks assuming the driver’s seat by taking the initiative for the creation of a local AMC without public participation or with minority public participation. All or a number of local banks join together to participate in a local AMC, with a totally separate and independent managerial and operational structure. Private sector investment must invariably be sought to join in the set-up and contribute to the funding part of the scheme. Selected parts of the banks’ NPL portfolios, and possibly of their real estate owned portfolios, are transferred in exchange for shareholding participation in the new venture. Arguably, a carefully constructed AMC can actually fall outside the scope of the Bank Recovery and Resolution Directive which would typically trigger off resolution for the participating banks (see, for example, the ECB’s Financial Stability Review, November 2016).
Admittedly, this is no easy or simple task, either organisationally and procedurally or with respect to funding and valuing the assets to be so transferred. It is a possibility nevertheless not to be outright overruled and discarded without some deliberation, given that it may present local banks’ only realistic opportunity to swiftly unclog their balance sheets and allow them to revert to their reason d’etre of financing the real economy.

Fifth quantum leap: “Merge and consolidate”

The local banking sector is undoubtedly hampered by excess capacity with too many banks chasing after too few credit-worthy opportunities. The intense competition is exacerbated by the unprecedented growth of alternative digitalised channels and financial technology companies on the one hand and sharply rising compliance, regulatory and reporting costs on the other hand.
As put forward by the CEOs of the country’s major banks in the recent Cyprus Economic Forum, consolidation will invariably take place. Indeed, there is no other way, particularly with regards to the many smaller banks operating in Cyprus, to gain economies of scale and cost efficiencies and sufficient clout in the market. Carefully carved-out mergers and acquisitions must be seriously considered by market participants and such strategic considerations must be placed high on the agenda of bank boards.

Conclusion

Successful revolutions are typically marked by speed, determination and decisiveness, unrelenting perseverance and tenacity, bold and daring moves, and intense flexibility and adaptability but also strict discipline at the same time. These are not typical traits of the conventional set-up of banking rationalism and conservatism.
In these critical times, however, whereby banks are striving to make ends meet and to de-congest their heavy loads which are suffocating their survival, revolutionary moves may indeed be their best bet to transform their future.
Of course there are no easy answers to the puzzle of how our banks’ future should be best preserved and nurtured. As Enria is quick to note in suggesting the creation of a pan-European AMC “my role here is simply to throw a stone in the pond… I am triggering a debate, not selling a fully-fledged proposal”. Likewise, this article does not assert to have all the answers or the nitty-gritty details; far from it. These are intricately complex issues which permeate the entire banking sector, its culture, its systems and its people.
Fundamentally, this article is proposing a more radical approach for the management of the key issues faced by local banks, the main one of course being none other than NPLs, as food for thought for fruitful deliberations about the future of our banks.
A future which, as things currently stand is, to say the least, uncertain in light of the multiple and severe pressures faced by the banking sector. The viability and sustainability of banks’ business models will undoubtedly come under intense regulatory scrutiny and questioning in the years to come.
It is, therefore, high time that banks start debating their futures and, indeed, the very essence of their viability and survival. There is substantial cumulative knowledge and expertise internationally which can be explored and exploited to assist the discussion.
To paraphrase John Hourican, CEO of the Bank of Cyprus, banks must face their existential threats head-on.
It is either bloom or wither time.