NPE
Definition
Non-Performing Exposure. Loans or other assets where the borrower has failed to meet contractual obligations.
What This Actually Means
Loans in default or approaching default. For IRRBB purposes, the question is not simply whether to include them, but how to model them. NPEs are still on the balance sheet and have a notional value, but the cashflows are uncertain and driven by credit recovery dynamics rather than contractual interest rate terms. The borrower is not reliably paying interest, so treating an NPE as an interest-bearing instrument at its contractual rate overstates the rate sensitivity of the asset.
Where It Matters
NPEs should generally be treated as potentially non-interest bearing — reflecting the reality that coupon receipts are uncertain or absent — and assigned a behavioural profile based on expected recovery timing rather than contractual maturity.
This means modelling NPEs as a pool of assets that will resolve — through recovery, restructuring, write-off, or sale — over a horizon derived from the bank's historical resolution experience, rather than as fixed-rate or floating-rate instruments repricing on a contractual schedule. The interest cashflows should reflect expected receipts, not contractual entitlements. In practice this often means modelling a significant portion of the NPE book as non-interest bearing, with the notional amortising out over the expected resolution profile.
Why this matters: including NPEs at their contractual repricing terms inflates the apparent size of fixed or floating rate positions and introduces noise from credit risk into the rate sensitivity picture. Excluding them entirely is cleaner but may understate the balance sheet and creates a documentation gap with regulators. Behaviouralisation is the defensible middle ground — it keeps NPEs in scope, models them realistically, and separates the credit recovery assumption from the interest rate assumption explicitly. The approach and its assumptions should be documented and subject to regular review as the NPE portfolio evolves.
Regulatory thresholds and proportionality: regulators have previously set thresholds around NPE treatment, and the materiality of the interest impact will depend heavily on the organisation's NPE levels. For banks with low NPE ratios, the rate sensitivity contribution of the NPE book may be immaterial relative to the performing portfolio, and full behaviouralisation may not be proportionate. However, this should not be assumed — it should be periodically tested and validated. If the NPE book is not behaviouralised, the bank should be able to demonstrate that the interest cashflow impact has been assessed and found to be below a justifiable materiality threshold, and that this assessment is refreshed as NPE levels change.
Defaulted or near-default loans. Debatable whether to include in IRRBB scope.