Western Europe: Bank provisioning for a rainy day
Post-2008 accounting standards set aside capital for tomorrow’s problem loans today. In doing so, they rely on the judgements of the banks themselves. However, after Covid-19, European banks cannot afford to provision for write-offs in the same way as their US counterparts.
No wonder investors struggled to believe the upbeat tone in European banks’ third-quarter 2020 results.
Given how much banks reduced and even wrote back provisions, you might have thought Covid-19 was over. Instead, the continent was just entering a second wave of infections and lockdowns, and the main vaccine test results had not even been made public.
Under the new accounting frameworks designed to prevent a recurrence of the 2008 crisis, banks are supposed to hike loan-loss provisions when they see risks increasing.
Nevertheless, most banks in Europe marked lower provisions in the third quarter of this year than the second. Analysts had expected them to set aside about twice as much as they did.
It is understandable to an extent.
Government support measures, such as furlough schemes and mandatory loan repayment holidays, will prevent some defaults. There’s little evidence in Europe, so far, of a big rise in loans that are objectively impaired. The lifting of restrictions over the summer gave the economy a jolt, and when banks were preparing third-quarter results, the second lockdowns had not been announced.
The known unknown is the impact on balance sheets when furlough schemes end
Yet the timing of those results – just as lockdowns were being reinstated in late October and early November – only added to widespread incredulity about banks’ projected losses.