ECB Urges Banks to Tackle Credit as Pandemic Support Expires

The European Central Bank is urging lenders to do a better job of gauging the risks they face from a potential spike in defaults as the pandemic increasingly hits companies and consumers.

The worsening economy has slowed banks’ efforts to reduce existing bad debts and “there is also an embedded level of distress in loan books that is not yet fully evident,” the ECB said in a statement on Thursday. Bloomberg reported earlier this week that the regulator was stepping up its scrutiny of bank loans.

European governments have deployed unprecedented amounts of stimulus to cushion the pandemic’s blow to the economy, guaranteeing loans and allowing certain borrowers to suspend interest payments. That has given banks more time to prepare for losses on credit, yet some European lenders have taken a less conservative approach in order to buoy earnings that are meager in comparison with U.S. peers.

“We’re now deepening our understanding and our analysis of the sectoral exposures of banks and the distribution of their customers,” ECB Supervisory Board Chair Andrea Enria told Bloomberg TV’s Francine Lacqua. The central bank is “trying to get a little bit more of a grip on the projections of asset quality throughout the year and the impact that the fallout of the pandemic will have on banks’ balance sheets,” Enria said.

The expiration of several support measures this year could increase the risk of “cliff effects,” the ECB said. The watchdog has “communicated a considerably higher number of recommendations” to banks to deal with credit risk, according to the statement.

The ECB and other authorities have also given lenders unprecedented regulatory relief to swallow losses in the pandemic and keep lending. As a trade-off to conserve capital, the central bank urged them to show restraint on dividends and bonuses, though some smaller banks have started to push back.

In general, big banks plan to comply with the recommendation. The ECB estimates lenders will probably pay out as much as 11 billion euros ($13.3 billion) under the cap. Officials plan to lift the limits by September, “if there is no surprising bad news,” Enria said on Bloomberg TV.

Governance Issues

The ECB is also stepping up its scrutiny of loans to highly indebted companies. That business, known as leveraged finance, has grown as banks hunt for returns in a low interest rate environment.

“To be honest, we have not seen an extremely positive reaction from banks, so they still have expanded in this market,” Enria said. “The share of loans which are highly leveraged and covenant-light has not decreased; it has actually increased. We are focused on these exposures, asking banks to contain these types of exposures and to have a lot of attention also at board level and in terms of robust risk management policies.”

The ECB said it has made recommendations to banks with narrow capital buffers to enhance their planning. The watchdog reiterated that banks can dip into capital reserves until at least the end of next year in order to keep lending.

At the end of September, nine banks had common equity Tier 1 ratios below their requirements and guidance prior to the measures the ECB enacted in response to the crisis.

The regulator also said:

  • Some banks have been slow to address governance issues in the pandemic, with management not overseeing business functions sufficiently
  • One in four banks faces delays in making more use of digital technology for internal processes
  • Banks should improve their efficiency

©2021 Bloomberg L.P.

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