Banks across Europe are being pushed or forced to grant loan-repayment holidays, resulting in growing calls in the sector for greater slack from regulators, particularly on the reporting of bad debts.
Investor worries about lower pay-outs – even emergency capital raisings – are weighing heavily on banks’ equity and subordinated debt values.
Global central banks have flagged that banks should eat into capital and liquidity buffers, which are generally much higher than they were before the 2008 financial crisis. The question, though, is whether it’s enough: especially as delayed payments by households and businesses should command higher provisions.
“We are facing a war; it’s probably much worse than a war,” said Giovanni Sabatini, general manager of the Italian Banking Association (ABI) after the country announced a nationwide quarantine on March 10.
“You cannot manage the current situation by saying ‘we have a set of rules that work during a normal economic cycle, so let’s live with it’.”
After the global financial crisis, regulators have demonized the word forbearance, as there was abuse of it. Forbearance, in situations like this, is perfectly justifiable- Gonzalo Gasós, EBF
Under the new IFRS 9 reporting rules, banks are supposed to automatically set aside more capital for losses if a loan is overdue only by 30 days – an approach Germany’s association of private banks, the Bankenverband, also argues should be tweaked during the outbreak.
The debate about loan reporting is particularly sensitive in Italy, as the European Central Bank (ECB) has spent years trying to get banks there to properly recognise and act on long-forborne loans, particularly to small and medium-sized enterprises (SMEs).
During the quarantine, SMEs could be particularly hard-hit, in part because government financial support for them may be more operationally difficult to administer, compared to stricken larger companies.
On the same day as the ECB’s March monetary policy meeting, the European Banking Authority (EBA) announced it would delay its 2020 stress tests until next year.
However, the ECB’s own comments on provisioning were so vague that they left analysts wondering whether IFRS9 norms, for example, would still apply – although the single supervisor is expected to push less hard on its implementation of more controversial provisioning norms, including its new calendar for 100% provisioning and targeted review of internal models (TRIM).
Even during the coronavirus Covid-19 outbreak, there’s still a strong current of opinion against allowing banks leniency on how they classify loans, in case improper reporting intensifies questions about the solvency of the bank.
“Opacity doesn’t help to create confidence,” says Thorsten Beck, a professor at London’s Cass Business School, who has written a chapter on banking in a new book on the economic impact of the coronavirus by the Centre for Economic Policy Research (CEPR).
Regulators should prefer to have banks eat into their capital, Beck argues – even if it means they fall below their capital requirements or need recapitalizing – even by taxpayers. Banks need to be crystal clear about the parts of their portfolios that are subject to enforced or voluntary payment holidays, he says.
Other supervisory relief measures announced by the ECB should, for now, reduce fears of missed coupons and dilutive rights issues. These measures, according to research from UBS, could free up about €240 billion of tier-1 capital, allowing them to absorb loan losses of a level far higher than UBS expects, although less than the level of losses incurred in the last crisis.
By far the biggest chunk comes from allowing banks to temporarily use their capital conservation buffer, amounting to 2.5% of risk-weighted asserts. Yet banks will avoid using that buffer, as it would be on condition of cutting dividends and bonuses.
The counter-cyclical buffer is the ideal tool – but it works less well in the eurozone, as it has been up to national regulators.
In Italy, the level has never been above zero. In Germany, it will be a case of not starting to raise the buffer this summer, as intended. Even in the UK, which had a 1% counter-cyclical buffer, it has already cut the buffer to zero.
Importantly, European banks are to be allowed to temporarily go below their liquidity coverage ratio and their pillar-2 guidance on regulatory capital – but this is an unknown benefit in the case of the latter, as the ratio is not disclosed.
The only permanent benefit is bringing forward plans to allow banks to meet part of their pillar-2 requirement through subordinated debt. Unfortunately, this is not much of a help at a time when the market for such instruments has dried up.
Italian banks, again, will have greatest need for these measures, and more. Almost as soon as the Italian government put a national quarantine in place, it started preparing a debt moratorium lasting several months, which will be obligatory for banks – and potentially applicable not just to households but also at least some businesses.
According to the ABI’s Sabatini, if they’re forced to suspend repayments by law, it’s all more reason for the EBA to make it clear that banks do not need to classify a previously healthy exposure as non-performing. Indeed, the European Banking Federation (EBF) is pushing for the same thing as forced moratoria are put in place elsewhere.
“After the global financial crisis, regulators have demonized the word forbearance, as there was abuse of it,” says Gonzalo Gasós, a supervision specialist at the EBF. “Forbearance, in situations like this, is perfectly justifiable.”
Government guarantees against forborne loans should help the banks. State-owned funds and banks, including Italy’s Cassa Depositi e Prestiti, France’s BPI and Germany’s KfW and have all been told to increase their loans and loan-guarantees to business borrowers affected by the coronavirus.
In Italy, even before the national quarantine, the government extended an existing vehicle to guarantee suspended debt repayments by low-income families after the death or serious illness of the main income earner, known as the Fondo Gasparrini. The fund will now apply to situations where the person’s job was lost due to the coronavirus.
After the imposition of a national quarantine, the Italian government further moved to extend a similar guarantee for SMEs, using another pre-existing fund.
Nevertheless, analysts remain sceptical, with UBS doubting the practicality of such schemes – the governance, record-keeping, returns considerations – and Barclays questioning the impact of the cost of it on sovereign spreads.