Circular Letter No. CC/2024/00000035

Circular Letter No. CC/2024/00000035
Sent to:
Credit Institutions.
Form. 99999975/T – 01/14
Subject: Supervisory expectations regarding policies and procedures for the identification and marking of borrowers in financial difficulties and of financial restructured credits for individuals

1. Under Article 115th-N of the General Regime of Credit Institutions and Financial Companies (RGICSF), credit institutions must have processes for the approval, amendment, extension, or refinancing of credit, established clearly and based on solid and defined criteria. They must also, inter alia, have effective systems for the ongoing management and control of credit portfolios, namely to identify and manage non-performing credits and to set aside, whenever applicable, provisions for expected credit losses that are adequate to the eventual realization of the risk of default.

2. In this context, the defined policies and procedures must allow for the adequate and timely identification of borrowers who are facing or are likely to face difficulties in meeting their financial commitments, as well as of credit contracts whose contractual amendments are associated with financial difficulties, hereinafter referred to as “financial restructured credits”. This classification aims to ensure that each institution correctly manages the credit risk to which it is or may be exposed, in order to ensure adequate accounting and prudential coverage of estimated current and future loss amounts. This results from what is defined in Article 47th-B of Regulation (EU) No. 575/20131 (CRR), in the relevant Guidelines2 of the European Banking Authority (“EBA”), as well as in the applicable accounting framework (“IFRS”3
   ).

3. Over the last two years, as a result of the increase in reference interest rates for individual credit contracts and, also, the introduction of temporary legislative measures to support families in the context of housing credits (namely via Decree-Law No. 80-A/2022, of November 25, and Decree-Law No. 91/2023, of October 11), a significant increase in the volume of amendments to the contractual conditions of housing credits has been observed.

4. The Bank of Portugal has been monitoring policies and procedures regarding the identification of borrowers with financial difficulties and of financial restructured credits for individuals, having identified very distinct practices in the application of the prudential and accounting frameworks.

5. In this context, and complementing the relevant EBA Guidelines and Bank of Portugal Circular Letter No. CC/2018/00000062, the Bank of Portugal publishes a set of supervisory expectations regarding credits granted to individuals (in the Annex), to be applied permanently by credit institutions, regarding the identification and marking of borrowers with financial difficulties and of financial restructured credits.

1 Regulation (EU) No. 575/2013 of the European Parliament and of the Council, of June 26, 2013, on prudential requirements for credit institutions.
2 Guidelines on the management of non-performing exposures and restructured exposures (EBA/GL/2018/06).
3 International Financial Reporting Standard 9 (“IFRS 9”) and Bank of Portugal Circular Letter No. CC/2018/00000062, of November 14, 2018.

Form. 99999924/T – 01/14
6. To the extent applicable, the expectations conveyed through this Circular Letter must be applied to the process of identifying borrowers in financial difficulties and of financial restructured credits in the remaining credit portfolio.

7. This Circular Letter does not, of course, dispense with the compliance with other requirements and guidelines related, in particular, to the identification of exposures in default (under Article 178th of the CRR, including the classification of “unlikely to pay”), of non-performing exposures (according to Article 47th-A of the CRR) or to the calculation of a provision for expected credit losses (within the scope of IFRS 9).

8. Without prejudice to the differences between regimes and concepts, institutions must promote, to the extent possible, coherence between the indicators used for the identification of borrowers in financial difficulties and the indicators of significant increase in credit risk4
   , for prudential and accounting purposes respectively, and the indicators of deterioration of the borrower's financial capacity for the purposes of Decree-Law No. 227/2012, of October 255 (PARI/PERSI regime).
   The assessment of the overall compliance with the expectations conveyed through this Circular Letter will be considered in regular supervisory processes.

4
Including those provided for in point 6 of Annex I to Circular Letter No. CC/2018/00000062.
5 Establishes principles and rules to be observed by institutions in the prevention and regularization of credit contract default situations and creates the extrajudicial network of support for banking clients.

Annex to Bank of Portugal Circular Letter No. CC/2024/00000035
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Form. 99999975/T – 01/14
Annex to Circular Letter No. CC/2024/00000035
Supervisory expectations regarding policies and procedures for the identification and marking of borrowers in financial difficulties and of financial restructured credits for individuals

A. General Aspects

1. The EBA Guidelines on the management of non-performing exposures and restructured exposures (EBA Guidelines EBA/GL/2018/06 or “Guidelines”)1 establish that credit institutions must regularly monitor the repayment capacity of borrowers, taking into account any signs of current or future financial difficulties that may impact their repayment capacity.

2. From a risk management perspective, credit institutions must be able to identify, at an early stage and on a continuous basis, signs of borrower financial difficulties. To this end, the assessment of the borrower's financial situation must not consider possible guarantees or securities associated with contracts and must not be limited to exposures with apparent signs of financial difficulties2
   . Thus, in addition to checking for payment delays on the date or in the recent past, credit institutions must consider other relevant information about the borrower's financial capacity, including prospective elements.

3. In this context, and in addition to the continuous assessment of the existence of financial difficulties, prior to the presentation of a contractual amendment proposal3
   , institutions must consider complete updated information on borrowers, to ensure the correct marking of financial restructured credits, in compliance with Article 47th-B of the CRR.

4. Without prejudice to compliance with Article 47th-B of the CRR, credit institutions must ensure an integrated view of the prudential, accounting, and risk management perspectives, as well as with the PARI/PERSI regime, highlighting the following exemplary situations:
   a) assess whether the marking of a given borrower in financial difficulties constitutes evidence of a significant increase in credit risk (“SICR”) of each operation of that borrower, which implies its classification in stage 2; b) consider the existence of financial restructured credits as evidence of SICR (stage 2), without prejudice to the necessary analysis for potential classification of the borrower as “unlikely to pay” and respective marking as a financial asset in credit impairment (stage 3) under IFRS 9;

1 The European Central Bank and the Bank of Portugal adopted these Guidelines regarding significant and less significant institutions under their supervision.
2 According to paragraphs 151 and 150, respectively, of the Guidelines.
3 According to the CRR and sections 6 and 7 of the EBA Guidelines EBA/GL/2018/06. It is emphasized that certain characteristics of restructurings require marking as restructuring for financial difficulties, as per letters c) to g) of paragraph 2 of Article 47th-B of the CRR.

Annex to Bank of Portugal Circular Letter No. CC/2024/00000035
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Form. 99999975/T – 01/14 c) ensure adequate articulation of the concepts of financial difficulties and of financial restructured credits with their risk management tools (Early Warning Systems, rating systems, watchlists, etc.); d) regardless of the existence of delays, the classification of a borrower in a situation of financial difficulties must always occur whenever, within the scope of an Action Plan for Default Risk (PARI), it is concluded that the borrower is at risk of default; e) mark as financial restructured credits the operations subject to contractual concessions agreed with borrowers integrated in PARI or Extrajudicial Procedure for Regularization of Default Situations (PERSI).

5. Institutions must have internal regulations, approved by the management body and subject to regular updates, defining at least the following aspects:
   (i) the quantitative and qualitative indicators for the identification of financial difficulties and the minimum frequency for their respective updates; (ii) the methodology to conclude whether a borrower is facing or may face financial difficulties; (iii) the procedures, clearly identifying those responsible for their application, for each phase of the process of identifying borrowers in financial difficulties, namely the collection of information, the update/quantification of indicators, the analysis of the same according to the defined methodology, and the marking of financial difficulties in information systems; (iv) the procedures, clearly identifying those responsible for their application, associated with contractual amendments of credit operations, for the identification and marking in information systems of financial restructured credits; (v) the procedures, clearly identifying those responsible for their application, associated with the assessment of the need to classify as stage 2 or as stage 3 of IFRS 9 the operations marked under the two previous letters.

6. The process of identifying, marking, and controlling borrowers in financial difficulties and of financial restructured credits must not be exclusively ensured by the first line of defense. Thus, the second line of defense must carry out effective control in all phases, ensuring the adequate assessment and marking of risk.

7. The institution's information systems must identify borrowers in financial difficulties, credits subject to contractual amendments, and financial restructured credits. Additionally, they must allow for the traceability of the process of identifying and marking borrowers in financial difficulties and of financial restructured credits, including the detail of all indicators identified at each moment, as well as the justification for marking or not marking.

Annex to Bank of Portugal Circular Letter No. CC/2024/00000035
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Form. 99999975/T – 01/14
8. Institutions must have procedures that ensure the quality control of the information reported to the Bank of Portugal regarding contractual amendments and restructuring measures for prudential purposes (FINREP and others) and statistical purposes (Central Credit Registry), ensuring that the information is consistent between different reports.

B. Methodology to identify borrowers in financial difficulties
9. Institutions must have a methodology to conclude whether borrowers are facing or may face financial difficulties. To this end, criteria must be defined that consider, individually, aggregated, or weighted, at least the following set of indicators of financial difficulties.

Marking as non-performing credit a) Existence of a credit operation classified as “non-performing”.
Delays in debt service in the last 6 months b) Recurring delays of less than 30 days in the debt service of any credit contract at the institution. c) Delay of more than 30 days in any credit operation at the institution or with other institutions, recorded in the Central Credit Registry (CRC) of the Bank of Portugal. Deterioration of credit quality d) Significant degradation of the internal risk classification in the last 6 months (“rating/scoring” assigned by the credit institution). e) Activation of internal alert levels (Early Warning Systems). f) Inclusion in a “watch list” for the purpose of strengthening credit risk monitoring. Liquidity profile g) Pattern of use of credit cards and/or overdrafts in the last 6 months that indicates liquidity difficulties, including, for example, their use for the payment of installments of other credits. h) Existence of factors that may lead to a significant reduction in the borrower's income source, such as negative evolution of the economic sector in which the borrower carries out their professional activity, unemployment, loss of income, divorce/separation, or other relevant factors. Debt Service to Income (DSTI) i) Effective DSTI ratio (without considering potential interest rate increases) equal to or greater than 50%, calculated based on the amount of monthly installments of all loans held by the borrower and their net monthly income (calculated based on annual income, divided by 12 months).

Annex to Bank of Portugal Circular Letter No. CC/2024/00000035
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Form. 99999975/T – 01/14
Other situations associated with financial difficulties j) Existence of relevant events and facts in the relationship with the institution itself or with other credit institutions, such as returned checks, partial debt forgiveness (principal and interest), write-off of debt values from assets, payment in kind, insolvency, litigation, attachment/seizure of bank accounts, which indicate situations of default. For this purpose, institutions must define for each type of event mentioned above an appropriate temporal observation period. k) Existence on the date of debts to the Tax and Customs Authority or to Social Security. It should be noted that, to the extent possible and according to proportionality criteria, institutions must automate the process of identifying individual borrowers in financial difficulties, especially with regard to the update/quantification of their respective indicators.