(Bloomberg Opinion) -- The pandemic has forced European governments to prop up their economies. They’ve rolled out furlough schemes, allowing millions of workers to keep their jobs, as well as “moratoria” suspending loan repayments for families and businesses. Now these countries face a dilemma over when to terminate such programs. Forcing companies to pay back debts too soon will put some promising ones out of business; postponing the inevitable for too long risks keeping zombie companies alive.
The puzzle over loan repayments speaks to a broader challenge facing financial regulators and supervisors. The European Central Bank has taken some steps this year to provide greater flexibility for lenders on prudential requirements, so that they can continue to support their customers. These measures — which include allowing banks to operate with less regulatory capital — will need to go eventually, but it is not yet clear when that will be. For now, the ECB needs to remain flexible, while resisting calls for a more permanent overhaul of its rules.
The steps taken to help the banking system include: granting banks permission to operate temporarily with less capital and liquidity, postponing the 2020 stress test and rescheduling inspections and remediation actions so banks could fully concentrate on handling the pandemic. In exchange, euro-zone banks have been told not to pay dividends.
Some lenders have avoided making full use of the additional capital and liquidity flexibility, fearing the adverse reaction of investors and the sudden tightening of supervisory standards. But many have faced requests from their customers to make use of the moratoria. These debtors may or may not be able to service their debt when the payment holiday expires, making it very hard for now to assess the pandemic’s impact on banks’ health.
Still, the sharp slowdown in demand makes it reasonable to assume that there will be a rise in non-performing loans, which in turn will prompt questions over the strength of lenders’ balance sheets.
So far, the ECB has taken a reasonable approach: It has made use of existing provisions allowing for lightening the supervisory burden on banks in exceptional circumstances. This stance provides sufficient flexibility going forward: If the economy recovers more slowly than expected, these exceptions could remain in place for some time. The same principle can apply to the moratoria too.
A different question is whether politicians should change regulation permanently, especially with regard to the provisioning of bad loans. Just before the current crisis, the euro zone had adopted tougher standards that require banks to write down the value of their non-performing exposures depending on fairly strict time criteria. The ECB has no option but to apply them, since they are now part of the EU rulebook. And yet, parts of the European banking industry are already complaining that these measures risk undermining the recovery and threaten financial stability in the wake of the pandemic.
Watering down the existing rules appears a tempting strategy in the short run, since it would make balance sheets look healthier than they are. However, it would recreate the very problem that occurred after the financial crisis of 2008 and the ensuing European sovereign debt crisis, as banks used supervisory forbearance to avoid dealing with their mounting bad loans. When the day of reckoning eventually came, it took years to clean up the system, with adverse consequences for economic growth and dynamism.
Governments must show they have learned their lesson. Rather than hiding new problems, banks will have to seek fresh capital from the market if needed. There may be a case for selective instances of state aid — for example via recapitalizations or the creation of so-called “bad banks” (asset management companies that deal with bad loans over time) — but these instruments must not be an excuse for keeping weak banks alive. Private investors must also be prepared to take a hit, rather than simply hoping to receive a taxpayer bailout.
The pandemic poses a set of new challenges for politicians and supervisors, but the euro zone has a useful set of rules it can rely on. Be flexible for as long as needed, but avoid turning back the clock.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Ferdinando Giugliano writes columns on European economics for Bloomberg Opinion. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.
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