ABSTRACT
This chapter examines the regulatory policies for non-performing loans (NPLs) in the context of the asset quality of banks. It considers the regulatory and accounting treatments of NPLs for the stability of the firm and the financial system. This chapter also discusses the different restructuring mechanisms, public and private, to resolve NPLs in the banking sector. The intervention of regulators and policy-makers reveals a cascade of soft law measures that create a grey area of non-binding provisions. This raises concerns for investors and financial institutions since there is a lack of a co-ordinated legislative framework for NPLs. In this context, increasing policy responses of supervisory authorities can be attributed to the following: (1) the proliferation of market failures in the business of NPLs, namely, information asymmetries, negative externalities and moral hazard; and (2) the poor incentives for investors and financial corporations to restructure non-performing exposures without public intervention. It is argued that although theoretically market failures are expected to exist in restructuring NPLs, empirically we do still find private resolving of bad loans occurring.
