Integrating Judicial and Extrajudicial Strategies in Portfolio Management

Integrating Judicial and Extrajudicial Strategies in Portfolio Management


By Asterios Kosivis, Business Consultant at QUALCO.

Managing loan portfolios becomes a labyrinth for financial institutions in a financial ecosystem marked by unrelenting complexity and constant change. The latter grapple with this formidable challenge amidst evolving regulatory norms and economic instability.  

Last year, discussions around the standardisation of insolvency laws across the European Union garnered substantial attention. This trend was observed in response to a surge in application filings from financially strained individuals. These individuals sought to counterbalance the cumulative impact of a rising cost of living and escalating mortgage interest rates. 

The near future, however, does not seem to hold much promise for significant improvement. Persistent inflation overshadows the European Central Bank’s target, and the European Union has officially entered a state of technical recession as of June, a consequence of two consecutive quarters of economic downturn. Consequently, financial institutions operate within an economy marked by contraction and sustained inflationary pressures. This scenario underscores the pressing need for resilient and adaptable strategies in managing loan portfolios. 

Although 2022 saw a modest reduction in Non-Performing Exposures (NPEs) across the European Union, financial entities, including banks and servicers, are advised to proceed with heightened vigilance. The critical role that effective system infrastructure plays in the successful execution of judicial and extrajudicial strategies for loan recovery is increasingly evident. 

To identify the best solution for Non-Performing Loans (NPLs), stakeholders such as lenders, servicers, and debt collection agencies need to deploy all available tools, starting a thorough appraisal of the NPL portfolio via a dedicated Workout Unit. In the past, creditors used to restructure sparingly, typically reserving it for situations where amicable collections appeared implausible.  

However, in the current environment, Workout Units approach cases with greater sophistication, strategically planning measures that often intertwine judicial and extrajudicial actions. This fusion emerges from the recognition that both strategies are invaluable tools that should feature prominently in the arsenal of every financial institution. 

Nevertheless, successfully deploying this hybrid strategy demands a robust and adaptable system infrastructure capable of handling the intricacies of judicial and extrajudicial procedures while ensuring strict adherence to regulatory norms.

Judicial Strategy Implications and System Requirements

Judicial strategies, which employ legal mechanisms to retrieve funds tied to non-performing loans, serve as a crucial safeguard for the financial health of an institution. These often involve initiating legal proceedings against debtors intending to repossess, auction, and sell collaterals or executing payment orders to seize the debtor’s assets or income. Regardless of the outcome and the ultimate objective of recovery, multiple implications could potentially jeopardise the entire strategy. It is, therefore, essential to navigate these strategies with utmost care and foresight. 

A significant factor to consider is regulatory compliance. Any non-compliance incident can result in severe penalties and damage the financial institution’s reputation. Contemporary collections and recovery software should offer configurable features and keep up with the evolutionary regulatory landscape through regular releases throughout the year. This ensures a prompt and accurate response to potential legislative changes. 

Moreover, this consideration significantly impacts resource allocation. Judicial proceedings typically demand substantial resources, including full-time employees, court fees, and other related expenses. Complicating matters further, many cases can be time-consuming to resolve, particularly in countries with intricate and sluggish legal systems. Also, some countries have strict deadlines and statutory limitations for claims to be pursued through legal actions (i.e., forclusion in France). Therefore, timing is critical. 

The solution to these challenges is a fully customisable software environment that allows users to establish comprehensive legal processes and any related actions concerning customers and accounts subject to litigation. A solution’s functionality on legal processes must be configured in terms of defined milestones and requisite tasks while enabling tailoring according to the complexities of local legal processes. Furthermore, users should capitalise on the system’s advanced self-service capabilities. Both automated and ad hoc steps should be incorporated alongside alerts. These features enhance the ability to delegate legal assignments to specific parties, establish deadlines, schedule follow-up dates, customise alerts, and allocate responsibilities to designated participants. 

Out-of-Court Workouts in Technical Extrajudicial Strategy

The out-of-court workout process, in some countries, referred to as an extrajudicial debt settlement procedure, aims to assist individuals experiencing financial difficulties by offering an alternative to formal insolvency proceedings. Several member nations of the European Union have adopted this approach. While the exact process may differ from country to country, the overarching goal is to offer a more efficient, cost-effective debt resolution avenue for debtors while ensuring the protection of their primary residences. 

The fundamental stages of the out-of-court workout process commonly encompass applying, followed by evaluation, mediation/negotiation, and approval, which leads to the process’s execution. As outcomes of the out-of-court workout process can fluctuate from one case to another, it is essential for creditors to meticulously outline the entire procedure and participate actively in negotiations with debtors, striving to achieve a mutually advantageous and sustainable agreement.

Hybrid Strategy_Schemas (1)The growing number of applications implies that from a technical standpoint, financial institutions need a solution capable of handling this influx efficiently and effectively, allowing them to: 

  • Coordinate their internal processes, obtain necessary approvals, and align their interests and priorities.
  • Assess the feasibility of proposed repayment plans and debt restructuring solutions. 
  • Balance their interests (based on no creditor worse off principle) and monitor the voting procedure with other creditors. 
  • Ensure the accurate tracking of the complex legal and procedural requirements.

Extrajudicial strategies frequently compel financial institutions to concede to lower recovery rates or extended repayment periods - particularly the latter in out-of-court mechanisms - and resolutions must be reached swiftly to enhance cash flow and improve balance sheet metrics. A system that fulfils these criteria guarantees this efficiency and provides the flexibility necessary to customise the conditions of a restructuring agreement. This adaptability is especially crucial considering the dynamic nature of out-of-court schemes. A well-configured system facilitates these modifications and ensures timely resolution to benefit all parties involved. 

Adopting A Hybrid Approach

The best situation for a financial institution is to balance judicial and extrajudicial strategies into a hybrid approach. This method allows a servicer to initiate legal proceedings to pressure a debtor while negotiating an extrajudicial settlement. 

Meanwhile, the economic landscape must be carefully considered to optimise debt recovery efficiency, shorten process duration, and reduce related costs. In a prolonged period of recession, where the economic output is dwindling, the paradigm shifts. Financial institutions such as banks and servicers must conduct meticulous assessments and calibrate their expectations concerning the economy, including prospective asset price recovery. 

These institutions must conduct a preliminary examination of the debtor’s circumstances, including their financial status, willingness to cooperate, and the loan specifics. This entails thoroughly segmenting and classifying non-performing loans based on various risk factors. 

Furthermore, these institutions would significantly benefit from a robust solution equipped with financial assessment functionality. This would allow for the estimation of reasonable living expenses, facilitating comparison and triggering pertinent alerts when income and expenditure statements of customers are registered. 

The ideal solution should also be configurable and maintain information regarding living standards in different countries, acknowledging other household profiles. This would be particularly beneficial for banks or servicers that operate internationally or need to assess the current financial situation of their clients who have migrated and are working in another country. 

The most notable benefit of the hybrid approach lies in its flexibility; however, this approach necessitates meticulous management and the necessary tools for a thorough understanding of the debtor’s circumstances and motivations. A solution furnished with a diverse array of functionalities could adeptly strike a balance between debt recovery and potential operating risk factors associated with overly aggressive legal actions or erroneous practices, especially in instances involving individual debtors. 

How QUALCO can help

QUALCO Collections & Recoveries (QCR) is an end-to-end Debt Collections & Recoveries (C&R) solution, enabling Credit Institutions, Investors and Servicers to manage the entire debt lifecycle. The software offers a unique suite of modules and functionalities that enhance operational efficiency to the maximum and combine judicial and extrajudicial strategies. Specifically, it incorporates the following:

1. Legal & Restructuring:

This module provides the tools required for designing and configuring complex processes, which combine the rigour required for compliance with an external set of rules and practices (such as the local legal framework) with the flexibility to accommodate alternative paths and optional steps. Given its capacity to manage a prominent level of complexity without being constricted to the characteristics of any judicial system, the module is notably fitting for the supervision of legal processes. Despite this specificity, its applicability to other business operations remains boundless, with loan restructuring processes in a debt collections environment exemplifying a key application area. The module is compliant and facilitates operations with:

  1. the local legal framework  
  2. the debt restructuring policies of the financial institution 
  3. legal cases that are handled internally  
  4. cases assigned to external Legal Offices 
  5. monitoring and performance evaluation 
  6. monitoring processes related to Collaterals or Real Properties (e.g., auction)

Furthermore, this module allows for establishing workflows, encompassing role management for data entry and state transitions. These transitions can be configured to adhere to a four-eye or maker-checker pattern of approvals when necessary. Tasks that need to be completed are associated as 'steps' with various process stages, and an advanced alert system ensures that assignees are notified in advance of task deadlines. The successful conclusion of most processes, particularly those on restructuring proposals, hinges on the customer satisfying specific criteria. The Covenants and Work Orders functionality aptly caters to this requirement – the latter pertains to scheduled reviews of the covenants during the process's Monitoring phase.

2. Expense Management: 

The QCR solution enables Recording, Processing and Monitoring the expenses of external parties for services they provide to the organisation. Also, users can configure in the system different Charges related to penalties, fees, expenses and other types of costs incurred on a case during its collection management and control the costs incurred on the case. Regarding charges and fees: 

  1. Charges related to penalties, fees, expenses, and other costs incurred on a case during its collection management. 
  2. Different Charge Types can be configured in the system and then related to one or more Clients, Portfolios or Debt items. 
  3. Charges can be configured to depend either on Debt Items or on Debt Values. 
  4. Charge Clients with subscription fees without attaching them to a specific case. 
  5. Charges may be registered automatically by the system when concern charge types are configured as such and manually by the users through the system’s screens.

3. Income & Expenditure:

QCR fully supports the registration of a Standard Financial Statement (called I&E Form) for individuals and companies, compliant with the recommendations of the European Central Bank.
The form enables users to maintain data on the financial status of the borrowers in one of the following categories:

  1. Income
  2. Expenses
  3. Property Assets
  4. Non-Property Assets
  5. Debts

Each of these elements can be further delineated flexibly. Using this information, the system monthly determines the borrower’s Disposable Income. The objective is to furnish comprehensive data on a restructuring or repayment process, ensuring a feasible agreement or solution is negotiated with the client. The functionality fully supports:

  1. Reasonable Living Expenses 
  2. Multiple I&E statements per customer and/or additional customer (incl. Partner’s data) 
  3. Full audit trail on I&E changes 
  4. Set up user-defined processes and alerts to revisit I&E in the future
Moreover, it facilitates the negotiations undertaken by agents/officers with customers regarding the organisation of debts under management or for the simulation of a restructuring solution, providing:

  1. Guidance to the agents towards the most appropriate solution for the customer with a compliant structured analysis of their circumstances. 
  2. Compliance with any local market and adaptation to regulatory changes through user parameterisation. 
  3. Updated customer’s financial positions and creation of up-to-date customer profiles.

Moreover, QUALCO Business Consulting can assist customers in combining Judicial and Extrajudicial strategies by:

Hybrid Strategy_Schemas (2)

Our consultants have extensive experience managing all aspects of Collections & Recoveries, ranging from early arrears to legal cases and covering mortgages, consumer finance and small business loans. This experience and QUALCO’s technological edge translate into ongoing strategic advantages. By adopting our customer-centric approach, your business can maximise operational effectiveness, reduce complexity and risk and enhance overall strategy. 

Are you ready to explore the hybrid approach?