Banking regulation flexibility during covid-19 crisis is coming to an end

In-depth analysis of the banking regulatory measures and supervisory practices taken during the pandemic (public guarantee schemes, moratoria in euro-area countries, accounting practices and NPLs treatment), examining how soon such policies can be normalized.

The report was made by Bruegel at the request of the ECON Committee and its  key takeaways are as follows:

• The euro-area banking system has played a relevant role during the crisis: According to the report, “it lent crucial support to the stabilisation of economies during the first set of pandemic-related lockdowns in 2020”. Lending standards eased and credit expanded in mid-2020, benefitting SMEs.
• Credit risk has remained low due to moratoria and public loan guarantees: The usage of that measures has been very large in the region, according to the report, at the end of the third quarter of 2020 the payment moratoria “covered 6.4% of the euro-area corporate loan stock, and an even larger share of SME loans” and, at the end of 2020, “public loan guarantees covered between 1-8% of GDP in the 4 largest euro-area countries”, explaining most of the credit growth in the currency union over the year. The report highlights that substantial credit risk will come “once supportive policies are ended”.
• But supportive banking regulation policies will come to an end: The EBA Guidelines on the exemption of moratoria loans runs until end of March. The granting of publicly-guaranteed credit runs until end-2021 and relief from various other projects in supervision is also coming to an end.
  The report points out that in some cases (i.e. moratorias) prolonging the measures again “does not make sense” and that “the ECB has already signaled much closer scrutiny of banks’ credit risk management, ending tolerance of poor practice”.
• The important role of the European Central Bank (ECB) and the European Banking Authority (EBA). According to the report both institutions “will need to address any perception among market participants that flexibility shown during the crisis implies that supervisors would continue to tolerate delayed recognition of loan losses and of non-performing assets. The withdrawal of these supportive measures, and the end of moratoria, will need to avoid the ‘cliff-edge’ risks of an abrupt policy change”.
• Banks’ NPL reduction strategies will be needed: To reflect the need for wide-ranging debt restructuring of companies that emerge from the crisis over-leveraged but still viable avoiding “fire-sale valuations of collateral in illiquid asset markets”.