Overcoming Non-Performing Loan Market Failures with Transaction Platforms

When banks judge that more value can be extracted by offering non-performing loans (NPLs) for sale rather than working them out themselves, potential investors cannot be sure that the credit quality of the assets is as good as the banks portray it to be. Such information asymmetries in the NPL market drive a wedge between the prices that investors are prepared to pay for NPLs and the prices that banks are prepared to sell them for. While information asymmetries can be overcome through investor due diligence, this requires specialist expertise and the costs of valuing NPL portfolios can be very high. As few investors have the resources to absorb such costs, barriers to entering the market are compounded. This appears to explain why the euro area NPL markets display the features of an oligopsony, a situation where there is a concentration of market power among a limited number of investors, which pushes traded prices even lower. At the same time, potential NPL investors can face coordination challenges when debtors have multiple loans with different banks. In such situations, investors must face the prospect of competing with other creditors for the debtor’s resources. While coordination between banks for common exposures may alleviate this problem, this too can be costly, weighing further on market prices. By offering the prospect of greater transparency in NPL markets, fostering wider investor participation and addressing coordination issues, NPL transaction platforms could help in overcoming all three of these market failures. The attendant improvement in market liquidity would allow banks to achieve better prices for NPL sales, preserve their capital and mitigate financial stability risks. This special feature outlines the desirable features of NPL transaction platforms and discusses their operational implementation. JEL Classification: G00