The European Central Bank has issued new guidelines requiring smaller banks across the eurozone to strengthen their provisions for long-standing non-performing loans, in a move designed to bolster the sector’s resilience and ensure consistency with larger institutions.

The guidelines, published on Monday, target so-called “less significant institutions” and will be phased in gradually until the end of 2028. These rules apply to loans that went sour before 26 April 2019, a category that had previously escaped the stricter provisioning schedules imposed on major banks. The ECB’s decision follows a recent uptick in non-performing loan ratios among smaller lenders, which rose from 1.7 per cent to 2.3 per cent, reversing a years-long downward trend.

Sharon Donnery, a member of the ECB’s Supervisory Board, commented on the persistent challenge posed by legacy bad loans. “Some smaller banks continue to face challenges stemming from persistent stocks of long-standing NPLs,” she wrote, noting that these institutions “maintain fewer reserves to cover potential losses” compared to their larger peers

The ECB’s approach aims to harmonise supervisory standards across the Single Supervisory Mechanism, ensuring that all credit institutions are subject to high-quality oversight. The central bank argues that timely and sufficient coverage of non-performing exposures encourages proactive risk management and reduces the stock of bad loans, ultimately supporting new lending and financial stability.

Under the new rules, national competent authorities will be responsible for reviewing the provisioning policies of less significant banks and ensuring that their treatment of non-performing exposures aligns with prudential requirements. Banks with negligible levels of bad loans will be exempted, and the ECB will consult with the industry on the guidelines until late October.

The ECB’s move comes as part of a broader effort to address the risks posed by legacy non-performing exposures, which can restrict banks’ capacity to lend and expose them to further losses if economic conditions deteriorate. The central bank’s guidelines also seek to prevent inconsistencies in the treatment of bad loans across the eurozone, particularly between those subject to deduction requirements under existing regulations and those that are not.

The new requirements are expected to prompt smaller banks to accelerate efforts to clean up their balance sheets, with the ECB emphasising the importance of a coherent and effective supervisory approach for the health of the European banking sector.

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