Four in five EU banks quizzed on credit risks in 2020

Covid panic exposed cracks in banks' credit models

European authorities sent recommendations on solving credit risk issues to 80% of banks in 2020, up from less than 50% the year before, clearly indicating where supervisors’ concerns lie in the wake of the coronavirus crisis.

Asks related to credit risk made up one-quarter of all qualitative recommendations sent to 112 banks directly supervised by the European Central Bank, compared with 17% in 2019. Almost two-thirds of these 2019 recommendations are yet to be taken up by banks, in part because the ECB extended the deadline for addressing these by six months in light of the Covid pandemic.

Of the 2020 credit risk recommendations, 22% concerned credit monitoring and reporting, 16% cliff effects linked to Covid-related loan moratoria, and 16% the IFRS 9 framework for accounting future expected credit losses.

 

Recommendations on cliff-edge effects were sent most frequently to lenders with large holdings of non-performing exposures and loans under moratoria. Asks linked to credit reporting focused on data aggregation issues, system limitations that led to patchy identification of loans under moratoria, and concerns over the application of management add-ons to credit provisions.

Apart from credit risk, supervisors sent recommendations to banks on their internal governance, capital planning, liquidity and business models. Findings on business model issues increased the most year on year, by 105%. Half of these concerned the sustainability of current business models.

What is it?

The Supervisory Review and Evaluation Process (Srep) is an annual bank-by-bank evaluation of capital adequacy undertaken by the ECB and is used to define appropriate minimum capital requirements for the following year.

Institutions are scored on seven topics: operational risk; internal governance; interest rate risk in the banking book; market risk; credit risk; liquidity risk; and business model risk. Srep scores range from one to four, with four being the worst.  A bank’s overall Srep score is used to assign Pillar 2 capital add-ons, which make up part of each bank’s binding minimum capital requirement.

Why it matters

Relief measures introduced at the start of the coronavirus crisis were intended to stoke lending to the real economy and prevent a slowdown turning into a full-fledged depression. But they ushered in new problems of their own. Specifically, they’ve made it harder for supervisors to gauge the safety and soundness of banks, particularly those with lots of loans under moratoria.

This explains the big increase in credit risk recommendations made by supervisors last year. Watchdogs have increased their scrutiny to ensure the relaxation of prudential measures and introduction of state guarantees won’t lure banks into trouble. What’s not clear is if and how banks will be able to implement all these recommendations, considering the strains they’re already under. The longer outstanding credit issues go unresolved, though, the more likely they are to cause serious problems in future. 

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