Circular Letter No. CC/2024/00000033 on Prevention and Regularization of Credit Default

Circular Letter No. CC/2024/00000033
Sent to:
Credit Institutions, Financial Companies, Payment Institutions and Electronic Money Institutions.
Mod. 40000375/T – 01/14
Subject: Understandings and best practices to be observed in the prevention and regularization of credit contract defaults

1. Institutions authorized to grant credit in Portugal must observe a set of legal and regulatory requirements aimed at protecting banking clients who face difficulties in fulfilling obligations arising from credit contracts, promoting the prevention and regularization of default situations.

2. In addition to the specific regimes applicable to housing and mortgage credit contracts (Decree-Law No. 74-A/2017, of June 23) and consumer credit contracts (Decree-Law No. 133/2009, of June 2), the regime approved by Decree-Law No. 227/2012, of October 25, in its current wording, establishes the general guidelines that should guide the actions of institutions in monitoring credit contracts and preventing default (PARI – Action Plan for Default Risk) and in negotiating, with banking clients, solutions for the regularization of default (PERSI - Extrajudicial Procedure for Regularization of Default Situations). It is also important to take into account Decree-Law No. 58/2013, of May 8, which, among other aspects, establishes limits on the amounts that institutions can charge banking clients due to the default of credit contracts. Additionally, other rules that, at the banking or civil level, must guide the actions of institutions in this scope must not be overlooked.

3. In addition to having concretized and developed some of these duties through regulation (namely, through Notice No. 7/2021), the Banco de Portugal has been monitoring their compliance by institutions, notably through the implementation of inspection actions, the analysis of complaints submitted by banking clients, and the systematic monitoring of information reported under Instruction No. 16/2021. In particular in recent years, marked by vicissitudes that placed pressure on the financial resilience of families, and motivated, even, the adoption by the legislator of exceptional and temporary measures, the Banco de Portugal gave priority to monitoring this regulatory framework, having carried out a cross-sectional evaluation of market practices.

4. In the context of this action, it was possible to observe the existence of distinct procedures and practices in the implementation of the applicable regulatory framework. Frequently, the identified differences reflect the existence of interpretative doubts, highlighting the need to clarify the Banco de Portugal's understanding of certain aspects of that regulatory framework. In other cases, the different procedures implemented by institutions find justification in the margin of discretion conferred by the legislator itself. Notwithstanding, even in these situations, it is considered that there is an advantage in promoting greater harmonization of these procedures, as it facilitates the understanding of the regime by banking clients who, frequently, have to deal, simultaneously, with more than one institution in the scope of procedures for prevention or management of default situations.

Additionally, the Banco de Portugal identified a set of best practices, which are already followed by some institutions, that should be disseminated among other institutions, with a view to strengthening the efficiency and effectiveness of their actions.

5. This Circular Letter thus aims to disseminate among institutions the Banco de Portugal's understanding of various aspects of the regulatory framework governing the prevention and management of default that raise interpretative doubts and whose non-observance may constitute an infringement of the applicable rules (identified as "Understandings"). Additionally, this Circular Letter disseminates to the market a set of best practices that the Banco de Portugal considers should be adopted by institutions, with a view to improving the protection afforded to banking clients in financial difficulties (identified as "Best Practices").

6. The Understandings, insofar as they reflect the interpretation of the current regulatory framework, must be incorporated into the procedures and practices of institutions promptly. For the implementation of the best practices, institutions have a deadline until January 1, 2026.

7. This Circular Letter does not dispense institutions from complying with legal and regulatory requirements not covered by the Understandings and best practices now issued. It does not, likewise, compromise the need to observe prudential requirements and guidelines, related notably to the identification of exposures in default, non-performing exposures, or with the calculation of expected credit risk losses. Finally, this Circular Letter does not affect the need for institutions to observe the accounting and statistical requirements to which they are bound.

8. Without prejudice to the differences between the aforementioned regimes and concepts, institutions must promote, as far as possible, coherence between the indicators used to identify the degradation of the debtor's financial capacity, for the purposes provided for in Decree-Law No. 227/2012, and the indicators of debtors in financial difficulties and significant increase in credit risk, for prudential and accounting purposes, respectively.

9. The assessment of the overall compliance with the Understandings and best practices transmitted through this Circular Letter will be considered in the inspection processes carried out by the Banco de Portugal.

Thus, in the exercise of the competence attributed to it by Article 17 of its Organic Law, approved by Law No. 5/98, of January 31, the Banco de Portugal disseminates the Understandings and best practices presented in the Annex.

Mod. 40000375/T – 01/14
ANNEX
Understandings and best practices to be observed in the prevention and regularization of credit contract defaults INDEX OF UNDERSTANDINGS AND BEST PRACTICES
Understanding 1: Scope of application of the General Default Regime............................... 5
Best Practice 1: Scope of application of the General Default Regime.................................... 5
Understanding 2: Charging of commissions for the renegotiation of the credit contract ................. 6
Understanding 3: Increase in the interest rate by the renegotiation of the credit contract ........ 7
Understanding 4: Charging of early repayment commissions associated with
refinancing or consolidation of credits.............................................................................. 8
Understanding 5: Increase in the interest rate or spread due to default of the credit
contract ........................................................................................................................................... 8
Understanding 6: Indicators of degradation of the client's financial capacity ........................... 9
Understanding 7: Automatic integration into PARI.......................................................................10
Best Practice 2: Waiver of communication of integration into PARI ...............................................11
Best Practice 3: Termination of PARI ..................................................................................................11
Best Practice 4: Timely integration into PERSI ..........................................................................12
Understanding 8: Date of default relevant for integration into PERSI......................... 12
Best Practice 5: Termination of PERSI.................................................................................................13
Understanding 9: Individual records per credit contract and integrated view of the client .....13
Best Practice 6: Channels for alerting the risk of default by clients............................. 14
Best Practice 7: Communication channels with clients.............................................................. 14
Best Practice 8: Calculation of the client's financial capacity in PARI or PERSI ...................... 15
Best Practice 9: Presentation of proposals adequate to the financial situation, objectives and
needs of the client ..............................................................................................................16
Best Practice 10: Provision to the client of information on the proposed solutions for prevention
or regularization of default........................................................................................... 16
Understanding 10: Credit categories in refinancing and consolidation
of credits...................................................................................................................................17
Understanding 11: Debit of installments of credit contracts in overdraft ....................... 17
Best Practice 11: Monitoring the effectiveness of agreed solutions ....................................18
Understanding 12: Conditions for the resolution or early maturity of consumer credit contracts...........................................................................................................18
Understanding 13: Resolution of the credit contract and declaration of early maturity of the
debt...........................................................................................................................................19
Understanding 14: Integration of credit contracts into PERSI before resolution or
early maturity ..............................................................................................................19
Best Practice 12: Interpellation of the borrower prior to resolution or early maturity
of the credit contract ................................................................................................................ 20
Best Practice 13: Information to be provided to borrowers in the communication of resolution or
early maturity of the credit contract ......................................................................... 20
Understanding 15: Recording and reporting in the scope of prevention and management of default.....20
Best Practice 14: Internal control systems in the scope of prevention and management of
default............................................................................................................................ 21
Understanding 16: Competence of workers involved in the prevention and management of
default............................................................................................................................ 21

Mod. 40000375/T – 01/14
I. SCOPE OF APPLICATION OF THE GENERAL DEFAULT REGIME
According to Article 2(1) of Decree-Law No. 227/2012, of October 25, in the wording in force (hereinafter, "General Default Regime"), institutions must observe the procedures provided for therein in the scope of prevention and management of default situations regarding the following credit contracts, concluded with consumers:
(a) Credit contracts relating to properties covered by Decree-Law No. 74-A/2017, of June 23, in its current wording; (b) Consumer credit contracts covered by Decree-Law No. 133/2009, of June 2, in its current wording; (c) Consumer credit contracts concluded under Decree-Law No. 359/91, of September 21; (d) Credit contracts in the form of overdraft facilities that establish the obligation to repay the credit within one month. Considering that the reference to the legal instruments regulating the different types of credit contracts may generate doubts regarding the actual scope of application of the General Default Regime, the following is clarified:

Understanding 1: Scope of application of the General Default Regime Institutions must ensure that the principles and rules established in the General Default Regime are applied to all credit contracts covered by its scope of application, which include:
(a) Consumer credit contracts with a contracted credit amount greater than 200 euros, regardless of the outstanding amount (even if less than 200 euros); (b) Real estate financial leasing contracts; (c) Financial leasing contracts for automobiles and other vehicles; (d) Credit overdrafts, including those with amounts less than 200 euros. Taking into account the concerns and principles underlying the General Default Regime, it is also considered good practice to apply it to all credit contracts concluded with consumers, even when amounts outstanding are less than 200 euros.

Best Practice 1: Scope of application of the General Default Regime Institutions must ensure that the rules established in the General Default Regime are observed regarding all credit contracts concluded with consumers, regardless of their nature and amount.

Mod. 40000375/T – 01/14
II. CHARGING OF COMMISSIONS AND INCREASE IN INTEREST RATE

1. Charging of commissions for the renegotiation of the credit contract
   In accordance with Article 8(1) of the General Default Regime, "[c]redit institutions are prohibited from charging commissions for the renegotiation of the conditions of the credit contract within the scope of this decree-law, notably with regard to the analysis and formalization of this operation". The charging of commissions for the renegotiation of the conditions of housing credit contracts was already prohibited before the entry into force of the General Default Regime, by virtue of Article 3(1) of Decree-Law No. 171/2008, of August 26, a solution that was maintained in Article 25 of Decree-Law No. 74-A/2017. Regarding consumer credit, the charging of commissions associated with the renegotiation of the credit contract is also prohibited, by virtue of Article 14-A of Decree-Law No. 133/2009, introduced by Law No. 57/2020, of August 28. The General Default Regime establishes principles and rules that are applicable to any situations of default risk or default of credit contracts covered by its scope of application, regardless of whether the credit contracts are formally integrated into the Action Plan for Default Risk ("PARI") or the Extrajudicial Procedure for Regularization of Default Situations ("PERSI"). Additionally, the aforementioned Article 8 is systematically inserted in Chapter I of the General Default Regime (under the heading "General Provisions"), not specifically falling within the chapters that regulate PARI and PERSI. Thus, the aforementioned prohibition on charging commissions for the renegotiation of the credit contract covers all agreements concluded for the prevention or regularization of default, even if the credit contracts are not formally integrated into PARI or PERSI. Additionally, the prohibition provided for in the aforementioned provision covers any commission associated with the renegotiation of credit contracts, and the reference to the "analysis and formalization" of the operation is merely exemplary.

Understanding 2: Charging of commissions for the renegotiation of the credit contract
2.1. Institutions must not charge any commissions for the renegotiation, refinancing, or consolidation of credit contracts aimed at the prevention or regularization of default situations, regardless of whether the contracts in question are integrated into PARI or PERSI.
2.2. The aforementioned prohibition on charging commissions covers, among others, commissions related to the analysis of renegotiation, the evaluation of guarantees, the alteration of contractual conditions, and the conclusion and formalization of a new contract.
2.3. The imputation to the client of any expenses incurred by the institution is legitimate.

Mod. 40000375/T – 01/14
2. Increase in the interest rate by the renegotiation of the credit contract
In accordance with Article 8(3) of the General Default Regime, "[c]redit institutions may not increase the interest rate of credit contracts within the scope of agreements concluded with banking clients aimed at the prevention or regularization of default situations". Similar to the prohibition on charging commissions for the renegotiation of the credit contract, the prohibition on increasing the interest rate covers any renegotiation agreed upon with a view to the prevention or regularization of default situations, regardless of whether this renegotiation occurs during PARI or PERSI.

Understanding 3: Increase in the interest rate by the renegotiation of the credit contract
3.1. Institutions must not increase the interest rate applicable to the credit contract within the scope of solutions (namely, renegotiation, refinancing, or consolidation) achieved with clients for the prevention or regularization of default situations, regardless of whether these solutions are agreed upon during PARI or PERSI.
3.2. The application of this prohibition must observe the following:
(a) In the renegotiation of credit contracts with variable rates, the prohibition on increasing the interest rate applies only to the applicable spread (fixed component of the APR), disregarding the variation of the index established in the contract; (b) In the refinancing of credit contracts, the APR (index and spread) applicable to the new contract should not be higher than that fixed in the refinanced contract; (c) In the consolidation of credits, the institution must not apply an interest rate higher than the weighted average interest rate by the outstanding amount of each of the consolidated credit contracts.

3. Charging of early repayment commissions associated with the refinancing or consolidation of credits
   In accordance with the legal regime of mortgage credit (cf. Article 23 of Decree-Law No. 74-A/2017) and the legal regime of consumer credit (cf. Article 19 of Decree-Law No. 133/2009), in the event of early repayment of credit, institutions may only charge a commission that represents a fair and objectively justified compensation for costs directly related to that repayment. The amount of the commission may not, in any case, exceed the limits legally established. When the early repayment results from the conclusion of a refinancing or credit consolidation contract with the same institution, the institution maintains its creditor position relative to the consumer, so it is understood that the charging of the early repayment commission is not legitimate.

Mod. 40000375/T – 01/14
Understanding 4: Charging of early repayment commissions associated with the refinancing or consolidation of credits Institutions must not charge commissions for the early repayment of credit contracts when this repayment results from refinancing or credit consolidation operations concluded with the same institution.

4. Increase in interest rate or spread due to default of the credit contract
   In accordance with Articles 8 and 9 of Decree-Law No. 58/2013, of May 8, in the event of delay in fulfilling obligations arising from credit contracts, institutions may only charge clients, due to late payment, (i) default interest, by applying a maximum annual surcharge of 3%, which adds to the remuneratory interest rate, on the due and unpaid capital, and (ii) a commission for the recovery of outstanding amounts, by due and unpaid installment, the amount of which must observe the limits legally established. Institutions may not charge clients other amounts on the grounds of default of obligations arising from credit contracts.

Understanding 5: Increase in the interest rate or spread due to default of the credit contract
5.1. Institutions must not increase the interest rate or spread contracted on the grounds of default of the credit contract.
5.2. Institutions must not increase the interest rate or spread of the credit contract, due to:
(a) Default of other credit contracts at the same institution; (b) Default of credit contracts at other institutions; or (c) Default of any ancillary obligations arising from the contract and/or occurrence of vicissitudes unrelated to the client.

III. SPECIFIC PROCEDURES OF PARI

1. Indicators of degradation of the client's financial capacity
   In accordance with Article 9 of the General Default Regime, institutions must ensure permanent and systematic monitoring of the execution of credit contracts concluded by them, carrying out, monthly, the necessary diligence to identify indicators of degradation of the client's financial capacity to fulfill obligations arising from these credit contracts. Indicators of degradation of the client's financial capacity include, notably, the existence of defaults registered in the Credit Responsibilities Central of the Banco de Portugal ("CRC"), the return and prohibition of the use of checks and corresponding insertion in the list of check users who pose a risk, the existence of tax and social security debts, their insolvency, the existence of judicial processes and litigious situations, the attachment of bank accounts, being in a situation of unemployment, the loss of income, or the unfavorable evolution

Mod. 40000375/T – 01/14 significant of the performance of the economic sector in which the banking client develops their professional activity, as well as the verification of defaults in other contracts concluded with the credit institution (cf. Article 9(4)). In addition to the aforementioned indicators, behavioral indicators are also relevant to assess credit exposure levels and the degradation of the client's financial capacity, contributing to strengthening default prevention mechanisms.

Understanding 6: Indicators of degradation of the client's financial capacity
6.1. In addition to the legally provided indicators and others that may equally be taken into account by the institution, indicators of degradation of the client's financial capacity include:
a) The existence of an effective DSTI (Debt Service to Income) ratio equal to or greater than 50%, calculated based on the amount of monthly installments of all loans held by the debtor, without considering potential interest rate increases, and on their net monthly income (calculated based on annual income, divided by 12 months); b) The verification, in the last 6 months, of recurrent delays less than 30 days in the fulfillment of the debt service of any credit contract at the institution; c) The pattern of use of credit cards and/or overdrafts (overdraft facilities and credit overdrafts) in the last 6 months, which indicates liquidity difficulties, including, for example, their use for payment of installments of other credits; d) The significant degradation of the internal risk classification ("rating/scoring") assigned by the institution in the last 6 months; e) Out