How to value bank loans in a crisis

By Burkhard Heppe


Published Thursday 26 March, 2020

The volume of legacy NPL is still elevated in many of the European countries which are now severely hit by the coronavirus pandemic. The longer the widespread lockdown of the economies continues, the more likely the economic shock will turn into another financial crisis with an increase in non-performing loans (NPL). Understanding the value of bank loans and NPL becomes a critical step when governments and supervisors must decide about how best to support banks to avoid a financial crisis and which institutions to bail-out. We discuss the different ways of valuing loans in the current crisis with a particular focus on NPL. We explain the different valuation methods with a focus on the valuations used in a bank resolution. We distinguish accounting from economic values for hold or sell strategies, respectively. We explain the significant data requirements imposed on banks by supervisors and analyse the data template for the valuation in resolution published by the European Banking Authority on March 10th.

Pointing to a lack of observable market price is certainly not a good enough answer to our question. Most bank loans and NPL were illiquid prior to the current crisis. To prepare the decisions about an imminent resolution, banks must be able to provide massive amounts of accurate data to resolution authorities and independent valuation experts often under extreme time pressure within a day or two. The task is enormous, but standardized datasets feeding advanced valuation technology will certainly help.

You can access the full technical paper by clicking here: How to value loans in a crisis?