European Banks Urged to Recognize Loan Losses Following Covid

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The European Union’s top banking regulator urged lenders to promptly write off loans that are failing in the aftermath of the pandemic, warning that without action “zombie” firms could damage the economic recovery.

Jose Manuel Campa, chairman of the Paris-based European Banking Authority, said in an interview on March 19 that regulators expect non-performing loans to “increase to a significant amount” in the coming quarters, after a year of government support for borrowers and banks suppressed defaults. There should be “as early recognition as possible” of losses, Campa said.

Despite EU banks setting aside billions of euros to cover souring debts, the actual ratio of non-performing loans declined to 2.6% at the end of last year, which Campa called “paradoxical” while Covid-19 plunged the economy into a recession.

“You need to do an assessment risk by risk, position by position and try to provision properly for those,” Campa said. The longer that borrowers rely on payment holidays, “the more likely you will see cliff effects because the more likely those loans may have deteriorated over such a long period of time,” he said.

“There will likely be firms that just don’t have viable business models exposed and they need to exit the market and they need to be liquidated,” Campa said.

European Banks Urged to Recognize Loan Losses Following Covid

The banks themselves have more capital to weather losses than they did in the financial crisis, yet Campa said authorities and the industry still need to guard against creating “zombie banks” that delay taking losses on loans but also hold back on new lending.

Campa’s position and recent warnings from the European Central Bank show that European authorities are preparing for the full effect of the pandemic to reverberate across the economy once temporary relief measures expire. The EBA is also resuming stress tests of banks this year.

Campa also said:

  • a post-Brexit memorandum of understanding, expected by the end of this month, would be a “first step” toward cooperation between British and EU financial authorities
  • regulators should continue “fine-tuning” rules on capital buffers to ensure they are used as designed during crises
  • global authorities need to work to maintain a level playing field on regulations, which may become more challenging as countries emerge from Covid-19 at different speeds
  • there should be more global coordination of regulations to combat climate change

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