Circular No. 2023-01 - Minimum Coverage of Banks' Non-Performing Credit Exposures

Circular on the minimum coverage of banks' non-performing credit exposures year 2023 / number 01 (Consolidated text as of 28/01/2025 – Update I)

INDEX

1. DEFINITIONS ...........................................................................................................................................................3

2. OBJECTIVES AND PRINCIPLES ...........................................................................................................................................4

3. SCOPE OF APPLICATION .................................................................................................................................4

4. SUPERVISORY EXPECTATIONS ON THE COVERAGE OF EXISTING NPE AMOUNTS ...............................5

5. SUPERVISORY EXPECTATIONS ON THE COVERAGE OF FUTURE NPE .........................................................6

6. REVISION OF SUPERVISORY EXPECTATIONS..........................................................................................7

7. ENTRY INTO FORCE ............................................................................................................................................7

8. DEFINITIONS

9. For the purposes of this Circular, the expressions used shall be understood with the following meaning:

• “age”: number of days (converted into years) elapsed between the date on which the exposure was last classified as non-performing and the reference date, regardless of the event that determined the classification as NPE. The age is calculated in the same way for all categories of non-performing credit exposures (including “probable defaults” and “overdue exposures”), with the counting continuing without restart for exposures that are reclassified into a different category within non-performing credit exposures;
• “supervisory expectations”: expectations of the Central Bank regarding the minimum coverage of non-performing credit exposures;
• “Central Bank”: Central Bank of the Republic of San Marino;
• “coverage”: accounting coverage and prudential coverage of non-performing credit exposures;
• “accounting coverage”: partial write-offs, analytical and flat-rate impairments, and provisions for guarantees and commitments, as per BCSM Regulation No. 2016-02;
• “prudential coverage”: capital coverage, in addition to those referred to in Article VII.II.6 of BCSM Regulation No. 2007-07, equal to any gap between the supervisory expectation for non-performing credit exposures and their relative accounting coverage;
• “credit exposure”: credit exposure as defined in Article I.I.3, paragraph 1 of BCSM Regulation No. 2016-02;
• “non-performing credit exposure” or “NPE”: non-performing credit exposure as defined in Article I.I.3, paragraph 3 of BCSM Regulation No. 2016-02, excluding unused credit lines that can be revoked unconditionally at any time without notice or provisions for automatic revocation clauses due to deterioration of the debtor's creditworthiness;
• “secured non-performing credit exposure”: non-performing credit exposure assisted, to an extent greater than 50% of the gross book value, by real or personal guarantees as per Articles VII.III.6 and VII.III.11, paragraph 3, letter c) of BCSM Regulation No. 2007-07;
• “unsecured non-performing credit exposure”: non-performing credit exposure other than secured non-performing credit exposures;
• “LISF”: Law No. 165 of 17 November 2005 and subsequent amendments;
• “NPE ratio”: ratio between the gross book value of non-performing credit exposures, as defined above, and the total gross book value of credit exposures, excluding from the ratio calculation any deposits with central banks and demand deposits with other credit institutions.

2. Unless otherwise specified, for the purposes of this Circular, the definitions contained in Law No. 165 of 17 November 2005, BCSM Regulation No. 2007-07, and BCSM Regulation No. 2016-02 apply.

3. In the subsequent articles of this Circular, words referring to the definitions in paragraph 1 are reported in UPPERCASE.

4. OBJECTIVES AND PRINCIPLES

5. This Circular defines the SUPERVISORY EXPECTATIONS regarding a multi-year convergence path towards complete COVERAGE of NON-PERFORMING CREDIT EXPOSURES, which the CENTRAL BANK expects banks to implement.

6. The expected multi-year convergence path is therefore aimed at a progressive reduction of credit risk inherent in the NON-PERFORMING CREDIT EXPOSURES held by banks, through the gradual and increasing establishment of COVERAGE at least equal to defined minimum levels, in order to achieve 100% COVERAGE of NON-PERFORMING CREDIT EXPOSURES within a determined number of years.

7. The expected multi-year convergence path that the CENTRAL BANK expects banks to implement is modulated according to the AGE of each NON-PERFORMING CREDIT EXPOSURE, whether it is assisted by a guarantee or not, the type of guarantee, as well as considering the specific NPE RATIO of each bank.

8. This Circular, in conformity with what is provided by Article 38, paragraph 5 of LISF and Article IV.I.1 of BCSM Regulation No. 2016-02, was subject to public consultation.

9. SCOPE OF APPLICATION

10. The SUPERVISORY EXPECTATIONS on the expected multi-year convergence path towards complete COVERAGE of NON-PERFORMING CREDIT EXPOSURES apply to:
    — UNSECURED NON-PERFORMING CREDIT EXPOSURES with AGE greater than 3 years; — SECURED NON-PERFORMING CREDIT EXPOSURES with AGE:
    a) greater than 9 years, if the gross book value of the exposure is assisted to an extent greater than 50% by real estate guarantees, including properties resulting from the resolution of lease contracts; b) greater than 7 years, in all other cases of SECURED NON-PERFORMING CREDIT EXPOSURES.

11. The SUPERVISORY EXPECTATIONS apply to amounts of both NON-PERFORMING CREDIT EXPOSURES that already meet the AGE criteria as of January 1, 2024, and NON-PERFORMING CREDIT EXPOSURES that will meet them after January 1, 2024, provided they concern credits granted before that date.

12. In the event of a modification after January 1, 2024, of the terms and conditions of the CREDIT EXPOSURE originating before January 1, 2024, which results in an increase in the operational limit, the CREDIT EXPOSURE is considered to have originated on the date the modification is applied.

13. SUPERVISORY EXPECTATIONS ON THE COVERAGE OF EXISTING NPE AMOUNTS

14. The SUPERVISORY EXPECTATIONS on the expected multi-year convergence path towards complete COVERAGE of amounts of NON-PERFORMING CREDIT EXPOSURES that already meet the AGE criteria as of January 1, 2024, concern:
    — an expected minimum level of COVERAGE on the initial date of January 1, 2024, when the multi-year path begins; — a subsequent expected minimum annual increase of 10% of the COVERAGE.

15. If the ACCOUNTING COVERAGE with reference to each NON-PERFORMING CREDIT EXPOSURE is lower than the relative SUPERVISORY EXPECTATIONS, the bank is required to cover the negative deviation with PRUDENTIAL COVERAGE of equal amount.

16. The SUPERVISORY EXPECTATIONS on the expected multi-year convergence path of each bank are modulated based on the bank's reference group and are summarized in the following table:

17. The reference group of each bank is determined based on the bank's NPE RATIO, determined on the initial date of January 1, 2024.

18. The reference groups provided are 3 and defined as follows:
    — Group 1: banks with NPE RATIO greater than or equal to 40%; — Group 2: banks with NPE RATIO lower than 40% and greater than or equal to 25%; — Group 3: banks with NPE RATIO lower than 25%.

19. On the initial date of January 1, 2024, depending on the reference group, the CENTRAL BANK therefore expects that each bank satisfies the initial SUPERVISORY EXPECTATION and therefore achieves an initial COVERAGE of each NON-PERFORMING CREDIT EXPOSURE at least equal to the minimum initial coverage provided, through the adoption of appropriate ACCOUNTING COVERAGE or PRUDENTIAL COVERAGE measures.

20. For subsequent years, the CENTRAL BANK expects that each bank satisfies the SUPERVISORY EXPECTATION in terms of a minimum annual increase equal to 10% of the COVERAGE, until achieving complete COVERAGE of each NON-PERFORMING CREDIT EXPOSURE within the expected deadline (by way of example, complete COVERAGE of SECURED NON-PERFORMING CREDIT EXPOSURES held by a bank in Group 2 is expected to occur by January 1, 2029).

Supervisory expectations on NPE coverage as of January 1, 2024

	Group 1<br>NPE ratio ≥ 40%	Group 2<br>25% ≤ NPE ratio < 40%	Group 3<br>NPE ratio < 25%
SECURED NPEs from:<br>- real estate > 9 years;<br>- other real or personal guarantees > 7 years
Minimum initial total coverage	40%	50%	60%
Initial date of convergence path start	01/01/2024	01/01/2024	01/01/2024
Minimum annual coverage increase	10%	10%	10%
Deadline for achieving total coverage (100%)	01/01/2030	01/01/2029	01/01/2028
Linear path before 7/9 years	No	No	No
UNSECURED NPEs > 3 years
Minimum initial total coverage	50%	60%	70%
Initial date of convergence path start	01/01/2024	01/01/2024	01/01/2024
Minimum annual coverage increase	10%	10%	10%
Deadline for achieving total coverage (100%)	01/01/2029	01/01/2028	01/01/2027
Linear path before 3 years	No	No	No

5. SUPERVISORY EXPECTATIONS ON THE COVERAGE OF FUTURE NPE
6. The SUPERVISORY EXPECTATIONS on the expected minimum COVERAGE for NON-PERFORMING CREDIT EXPOSURES that subsequently to January 1, 2024, will meet the age criteria, provided they relate to credits granted before that date, are summarized in the following table:
7. The CENTRAL BANK, with reference to NPEs referred to in the previous paragraph, therefore expects that each bank satisfies the SUPERVISORY EXPECTATION and thus that:
   — for SECURED NON-PERFORMING CREDIT EXPOSURES, it achieves at least 50% COVERAGE upon reaching an AGE of 9 or 7 years, provides minimum annual increases of COVERAGE equal to 10%, and therefore achieves complete COVERAGE within five years; — UNSECURED NON-PERFORMING CREDIT EXPOSURES, it achieves at least 60% COVERAGE upon reaching an AGE of 3 years, provides minimum annual increases of COVERAGE equal to 10%, and therefore achieves complete COVERAGE within four years.
8. Banks may reach the minimum initial coverage not necessarily through a linear path, therefore also adopting COVERAGE paths for NON-PERFORMING CREDIT EXPOSURES not distributed homogeneously in the years preceding the application of the SUPERVISORY EXPECTATIONS.

Supervisory expectations on coverage of future NPEs relating to credits granted before January 1, 2024

	SECURED NPEs from<br>- real estate > 9 years;<br>- other real or personal guarantees > 7 years	UNSECURED NPEs > 3 years
Minimum initial coverage	50%	60%
Minimum annual coverage increase	10%	10%
Deadline for achieving total coverage (100%)	5 years	4 years
Linear path before 7/9 years	No	No
Linear path before 3 years	No	No

6. REVISION OF SUPERVISORY EXPECTATIONS

7. If the COVERAGE is lower than the SUPERVISORY EXPECTATIONS, the bank has the burden of documenting in advance to the CENTRAL BANK, with at least 30 days' notice prior to the deadline for submitting the relevant prudential supervisory report, the reasons supporting such deviation for each of the NON-PERFORMING CREDIT EXPOSURES that contribute to determining it.

8. In cases where the CENTRAL BANK does not consider the reasons provided acceptable based on the elements acquired via documentation and/or inspection, it proceeds to adopt specific measures against the bank pursuant to Article 10 of Delegated Decree No. 50 of March 26, 2019, or Article 44 of LISF, unless alignment is achieved by the bank following the adversarial proceedings initiated.

9. ENTRY INTO FORCE

10. This Circular enters into force on May 15, 2023.