Sell or Hold? On the Value of Non Performing Loans and Mandatory Write-Off Rules

32 Pages Posted: 23 Nov 2020

See all articles by Florian Pauer

Florian Pauer

Vienna University of Economics and Business - Department of Finance, Accounting & Statistics

Stefan Pichler

WU - Vienna University of Economics and Business - Department of Finance, Accounting and Statistics; VGSF (Vienna Graduate School of Finance)

Date Written: October 5, 2020

Abstract

This paper investigates the decision rational banks face when considering selling a non performing loan (NPL). We start with developing a risk neutral pricing model for non performing loans and show that even if a bank and a potential buyer agree on the expected recovery value a difference in the precision in the estimation of the drift of the underlying recovery process may greatly influence the decision to sell a NPL. This difference could be due to private information of the bank about the borrower’s loan history or due to a larger sample of similar borrowers where defaults can be observed. Furthermore, the question if it is optimal to hold on to a NPL is also affected by capital requirements and funding costs banks typically face. This question is of particular interest in the light of mandatory write-off policies, which basically force banks to write-off/provision for NPLs after some time has passed. This raises the question whether or not banks are incentivized to sell NPLs at prices that are too low and thus represent a wealth transfer from banks to other capital market participants. Given the results presented here it can be concluded that these rules would indeed lead to the aforementioned transfer and these policies should be refined to incorporate a bank' ability to estimate time-series properties of a NPL's underlying recovery rate process.

Keywords: non performing loan, mandatory write-off rules, provisioning backstop

JEL Classification: G13, G21, G28

Suggested Citation

Pauer, Florian and Pichler, Stefan, Sell or Hold? On the Value of Non Performing Loans and Mandatory Write-Off Rules (October 5, 2020). Available at SSRN: https://ssrn.com/abstract=3705251 or http://dx.doi.org/10.2139/ssrn.3705251

Florian Pauer (Contact Author)

Vienna University of Economics and Business - Department of Finance, Accounting & Statistics ( email )

Welthandelsplatz 1
Vienna, 1020
Austria

Stefan Pichler

WU - Vienna University of Economics and Business - Department of Finance, Accounting and Statistics ( email )

Heiligenstaedter Strasse 46-48
Wien 1190
Austria

VGSF (Vienna Graduate School of Finance) ( email )

Heiligenstaedter Strasse 46-48
Vienna, 1190
Austria

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