European banks urged to recognize loan losses as a result of Covid

(Bloomberg) – The European Union’s main banking regulator has urged lenders to quickly write off loans that fail in the aftermath of the pandemic, warning that without action ‘zombie’ companies could harm 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 significantly” in the coming quarters, after a year of government support to borrowers and banks have removed defaults. There should be “as early recognition as possible” of the losses, Campa said.

Although EU banks set aside billions of euros to cover sour debts, the real ratio of non-performing loans fell to 2.6% at the end of last year, which Campa said. described as “paradoxical” while Covid-19 plunged the economy into a recession.

“You have to do a risk-by-risk, item-by-item assessment and try to provision them properly,” Campa said. The more borrowers rely on payment holidays, “the more you are likely to see cliff-edge effects, because the more these loans have likely deteriorated over such a long period,” he said.

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

The banks themselves have more capital to deal with losses than they had during the financial crisis, but Campa said authorities and industry should always be careful not to create ‘zombie banks’ that delay taking losses on loans but also withhold new loans.

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

Campa also said:

  • a post-Brexit memorandum of understanding, expected by the end of this month, would be a “first step” towards cooperation between British and European financial authorities
  • regulators should continue to refine the rules on capital buffers to ensure they are used as intended during crises
  • global authorities must strive to maintain a level playing field in regulation, which may become more difficult as countries emerge from Covid-19 at different speeds
  • there should be more global coordination of regulations to tackle climate change

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