EU banks eye bad loan relief from state guarantees

ECB move should prevent rickety loans counting as NPLs

Eurozone public guarantees and payment stays in excess of €1 trillion ($1 trillion) could be used by the region’s banks to claim relief from non-performing loan (NPL) rules.

On March 20, the European Central Bank said it could give lenders a break on debtors deemed “unlikely to pay” if their obligations are covered by government guarantees issued by European Union member states. Usually, an asset classified as “unlikely to pay” becomes a non-performing loan (NPL) and subject to heightened loss reserve requirements.

European Banking Authority data shows that 2.9% of aggregate loans and advances were classified as NPLs as of Q3 2019. Many more could become NPLs as the coronavirus crisis escalates. As of Q3, 6.9% of all loans were classified as ‘stage two’ under IFRS 9 accounting rules, meaning their credit risk had increased significantly since initial recognition. Such loans could tumble into the NPL category in a virus-triggered recession.

Banks in Cyprus, Greece, and Romania had the most stage two loans as a share of their totals as of Q3, at 15%, 14% and 13%, respectively.

 

With the ECB action, however, some of these could be spared NPL status. The German government has pledged loan guarantees of up to €600 billion, and raised the risk assumption rate on loans to existing businesses and start-ups as well as the guarantee limit for state-supported guarantee banks. France said it would back €300 billion of bank loans while the state-backed investment bank, BPI, would make €5 billion of zero-collateral loans and give payment holidays to certain types of borrowing taken by small- and medium sized enterprises.

Italy, Finland, Sweden, and the Netherlands are among the other member states that have already or plan to extend loan guarantees that could be used to defer NPL status.

 

What is it? 

NPLs are past-due loans that are not producing income. Firms are required to set aside more cash against these exposures to cover expected losses, pulling resources away from profitable investments.

Why it matters

Allowing bad loans to be carved-out of NPL rules could save European banks from having to divert more cash into loan-loss buffers at a time when governments want more to be pumped into economies getting suffocated by the coronavirus crisis.

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