NPL backstop: When the clock runs out on non-performing loans

A cooperative bank with total assets of around 1 billion euros has, in its 2025 management report, transparently calculated what the NPL backstop means for its own funds. ^{1, 2} According to this, its deduction item “will rise from the current €1.1 million to €18.3 million in 2028” and then fall again to €4.7 million². The peak figure corresponds to almost 14 per cent of its regulatory capital and directly reduces its common equity tier 1 capital. This poses challenges for the bank in meeting its capital requirements². As other savings banks and cooperative banks may also face similar burdens, this article sets out the underlying rules and contextualises them.

The term ‘NPL backstop’ encompasses two mechanisms that differ in their legal nature and effect:

• Pillar 1 (Art. 47c CRR): For exposures originated on or after 26 April 2019, the so-called shortfall in coverage of non-performing exposures must be deducted from Common Equity Tier 1 capital. The Regulation applies directly to all institutions.
• Pillar 2 (ECB Guideline (EU) 2025/2595): For older exposures, the ECB sets out guidelines for national supervisors on how to assess the coverage under the SREP. The Guideline does not provide for a specific deduction, but it may have a similar effect through supervisory measures.

The following sections first outline both sets of rules, followed by an analysis.

Capital deduction for ‘new’ non-performing exposures

For exposures established on or after 26 April 2019, Article 47c of the CRR stipulates a minimum coverage requirement (see Note 1). If, in the case of a non-performing exposure, the existing coverage (see Note 2) falls short of this requirement, all institutions must deduct the difference from their Common Equity Tier 1 capital.

Two points should be noted in this regard:

• The time is measured from the date of classification as non-performing, not from the date of origination.
• Only assets recognised as collateral for the purposes of calculating own funds requirements count as collateral; the economic value of the collateral does not.³ Special rules apply, amongst other things, to publicly guaranteed portions and to the first deferral, which freezes the factor for one year.

Figure 1 shows the minimum coverage ratios. It also illustrates the transitional caps for existing portfolios, which are explained in the following section.

Legacy holdings and ECB Guideline (EU) 2025/2595

Positions established prior to 26 April 2019 are exempt from the Pillar 1 deduction. If the bank subsequently increases a risk position due to changed conditions, it is deemed to have been newly established (Art. 469a CRR)⁴.

The ECB Guideline⁵ has applied to these legacy exposures since December 2025. It is addressed to national supervisory authorities – in Germany, the BaFin – and is binding on them.⁵ Compared with exposures arising on or after 26 April 2019, the key difference is that the Guideline does not create a second deduction. Instead, the result is incorporated into the SREP. In the event of insufficient coverage, the supervisory authority will consider measures under Article 104 of the CRD, such as a capital surcharge or the imposition of specific risk provisions.^{5, 6} Such an order may have an economic effect similar to a deduction from common equity tier 1 capital.

In mathematical terms, the Guideline follows Article 47c of the CRR, but without its deferral rule. For the reference dates of 2025, 2026 and 2027, the minimum coverage ratios are still capped at 60, 70 and 80 per cent respectively; from 31 December 2028, the full ratios will apply.⁵ For the first reference date, 31 December 2025, the supervisory authority was still permitted to waive the requirement to include this in the SREP. ⁵

The supervisory authority may exempt an institution for each reference date, for example where the gross NPL ratio is below 5 per cent or where the proportion of legacy portfolios is only insignificant. It may exempt individual positions upon application and subject to robust evidence: in the case of ongoing repayment from the debtor’s cash flow, where technical guarantees are in place, or where coverage and Pillar 1 capital together exceed 100 per cent. However, there is no automatic exemption.^{5, 6} The Dutch DNB, for example, already applies the guideline where the NPE ratio exceeds 3 per cent.⁷ BaFin has not yet published any specific guidance on this matter.

Classification for the institutions

For the sake of simplicity, let us assume that all loans were granted on or after 26 April 2019. Let us first assume that a large number of property loans, which are considered fully secured, were classified as non-performing in November 2022 due to the rise in interest rates. In that case, at least 35 per cent of these loans must be covered by loan loss provisions in the 2026 annual accounts; otherwise, the shortfall must be deducted from common equity tier 1 capital. This minimum coverage ratio rises to 100 per cent by the 2031 financial statements. If a portion is not recognised as secured, the minimum coverage ratios for unsecured portions apply, which increase even more rapidly (see Source 4).

Let us also assume that, in November 2026, a large number of unsecured loans are classified as non-performing. In that case, these must be covered at a rate of 35 per cent in the 2028 financial statements and at 100 per cent from the 2029 financial statements onwards; otherwise, the shortfalls must be deducted from Common Equity Tier 1 capital. The impact therefore begins earlier than the often-cited three-year period would suggest. Furthermore, in the 2028 and 2029 annual accounts, the deductions from both examples will increase simultaneously.

The example institution cited demonstrates that the effects can be significant. Therefore, as part of its capital planning and the normative perspective of the ICAAP, every institution should assess the extent to which the NPL backstop leads to deductions from core capital or to higher capital requirements that have not yet been taken into account.

Areas for action

The following areas for action emerge from the discussion so far.

1. Data basis: Record contract amendments, effective date, classification date, deferrals and recognised collateral by type of collateral for each position.
2. Planning: Update the capital shortfall over the planning horizon; for existing portfolios, including the transition path set out in the guideline, even under adverse scenarios, as part of capital planning within the ICAAP.
3. Manage coverage: Risk provisioning, realisation, write-offs or sale; only items in accordance with Article 47c(1)(b) of the CRR are eligible, i.e. no lump-sum value adjustments.
4. Prepare for exemptions: Document evidence for exemption applications in accordance with the Guideline at an early stage.
5. Monitor thresholds: The gross NPL ratio, as defined in the Guideline, must be included in risk reporting, as must the proportion of legacy portfolios in the total non-performing exposures.

Conclusion

The NPL backstop affects primary institutions in two ways: via Pillar 1, it covers non-performing exposures arising on or after 26 April 2019, and via the ECB Guideline, it covers the legacy portfolios of LSIs. The example mentioned at the outset, involving almost 14 per cent of own funds, illustrates the scale of the potential impact. Those who record their positions accurately and track their progress will recognise at an early stage just how sharply own funds may fall and how much own funds requirements may rise.

There is not much time left: from the 2028 reporting reference date, the full minimum coverage ratios will also apply to legacy portfolios, and the unsecured portions of positions that became non-performing in 2024 and 2025 will then have to be fully covered.