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Europe’s top banking supervisor is writing to the region’s biggest lenders to warn that many of them are failing to do enough to prepare for a likely increase in bad loans due to the fallout from the coronavirus pandemic.
Andrea Enria, president of the European Central Bank’s supervisory board, said the shortfalls in banks’ preparations for a likely rise in bad loans was one factor to be considered in its decision on whether to allow them to resume dividend payments and share buybacks.
Speaking at the Financial Times Global Banking Summit, Mr Enria said some of the 117 banks it oversees were “all over the place” on provisioning for the likely rise in non-performing loans. This was “a concern” for supervisors, he warned.
The ECB ordered eurozone banks to stop all dividends and share buybacks to conserve €30bn of capital in March, shortly after the pandemic arrived in Europe. Since then, the sector has been lobbying hard for stronger banks to be allowed to resume capital distributions early next year.
Mr Enria said “there is genuinely an intensive debate” at the ECB over whether to allow some banks to resume payouts to shareholders. He said the macroeconomic outlook would also be a factor in its decision, which is due to be announced after the ECB publishes its new 2023 forecasts on December 10.
“We will actually come out with what we call a ‘Dear CEO’ letter to the banks under our supervision in which we will highlight some issues we want them to address in terms of their approach to credit risk,” he said. The move is expected to be announced by the ECB on Friday.
The ECB has warned banks that under a severe scenario it modelled recently they could face an extra €1.4tn of non-performing loans, more than in the 2008 crisis.
Mr Enria said the ECB would “challenge the banks” to come up with “reliable projections that could make us sufficiently reassured that they can do it and they really have sufficient space to restart their own payments to their own shareholders”.
He said eurozone banks were split into “three buckets”: one group has reassessed each client individually in light of an expected deterioration of credit risk; a second group has taken sizeable general provisions without precisely identifying which clients are at risk of default; and a third group has taken “a wait-and-see approach”. The third group was now the ECB’s main supervisory focus and concern, Mr Enria said.
The ECB’s financial stability report published on Wednesday said banks could face a second wave of loan losses, especially if governments withdraw their loan guarantees and debt moratoria before the economy has fully recovered.
It said provisioning by eurozone banks “remains below levels observed during previous crises and those in other jurisdictions, notably the US”. It added that bank provisions were also “lower than what would have been suggested by historical regularities, although this may be partly explained by the impact of extraordinary policy measures in reducing credit risk”.
Mr Enria said there was a risk of a “cliff edge” for banks that did not take sufficient provisions being faced with a surge in bad loans, which he said could “clog their balance sheets and make them unable to actually support the recovery”.
This week the European Banking Authority said it would reintroduce measures giving banks more flexibility in how they provision for loans subject to Covid-19 forbearance. But the EBA stressed the need for responsible reporting of risks that emerge.