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ECB urges banks to be cautious about credit risks

E.uropa’s banking supervisors are increasing the pressure: The European Central Bank (ECB) has issued a letter warning the CEOs of the 113 banks it directly supervises to be more careful when dealing with credit risks in view of the increasing corporate insolvencies in the pandemic. In a letter published on the Internet, the head of the ECB’s banking supervision, Andrea Enria, called on the institutes to assess and classify these risks appropriately and to make adequate provisions in their balance sheets.

In a blog post published parallel to Enria’s letter, Elizabeth McCaul, member of the ECB’s supervisory body, pointed out the different practices in European banks. So there is a group that is still waiting and forming small provisions for impending loan defaults. Another is limited to blanket, general value adjustments, but does not go into the individual risks of the debtor. Finally, there are also banks with which the ECB supervisors are satisfied, because they have already assessed the credit risks in great detail and then set up provisions.

In the past few weeks, Enria has not grown tired of warning the banks of the outstanding damage from the corona pandemic. Because in a severe economic downturn, which the ECB describes with a decline in economic output (gross domestic product; GDP) of 10 percent in the current year, the Italian considers an increase in non-performing loans to 1.4 trillion euros possible. There are currently 503 billion euros in bad loans on bank balance sheets. In November 2014, when the ECB banking supervision started, it was more than 1 trillion euros.

Enria is therefore strongly in favor of settlement platforms, the so-called bad banks. In his opinion, a European network of these platforms should take the bad loans from the banks and sell them on on the market. The financing should be supported with European funds. At the same time, the pricing for the transfer of the loans should be regulated at European level. But in view of the high legacy of bad loans on the balance sheets of Italian and Greek banks, this proposal may raise concerns in Germany because of the pooling of risks.

Warnings came on Monday from Basel from the Bank for International Settlements (BIS): They fear that the high valuations on the stock and bond markets have decoupled from the uncertain economic outlook. In its quarterly report, the “Bank of the Central Banks” mainly refers to the banks’ stricter lending standards, which are the result of greater caution in the Corona crisis. On the other hand, the purchases of corporate bonds by the central banks would have caused the prices of the paper to rise and reduce risk premiums.

The banks are also aware of the growing credit risks. Before the weekend, Gerhard Hofmann, member of the board of the Federal Association of Volks- und Raiffeisenbanken, stated that after the suspension of the obligation to file for insolvency for over-indebted companies at the end of the year, corporate insolvencies would most likely increase significantly: Percent higher number of bankruptcies. “

No talk of a banking crisis

Hofmann referred to an assessment by the Deutsche Bundesbank, according to which this should be manageable for the banks in Germany. Hofmann, who was formerly the chief banking supervisor of the Bundesbank, pointed out the special responsibility of supervisors when making public statements during this phase. Because the impression should not be given that the next systemic banking crisis is imminent.

After the news about corona vaccines, the capital markets recovered significantly in November, writes the Basel-based BIS, which manages foreign exchange reserves for central banks and is an economic think tank. But now the valuations are above or near the levels before the pandemic. Even then, possible overvaluations were an issue, said BIS chief economist Claudio Borio. The reasons he cited were the very expansionary monetary policy of the central banks and the investors’ hunt for returns, which led to a higher risk appetite. Borio also expects more corporate bankruptcies.

In his view, the institutes entered the Corona crisis with strong balance sheets. They now served as a buffer for the economy, which is why they must continue to have sufficient resources, i.e. capital and liquidity, at their disposal. To this end, supervisory authorities such as the ECB have granted the banks capital relief so that they can continue to grant loans. Borio can understand the restraint demanded by the supervisors with regard to dividend payments. Investors may not be happy about this, but they would suffer too in serious distress. Borio makes whether the banks can get into a crisis depending on the course of the pandemic.

According to the ECB’s economic forecast on December 10th, the supervisors want to decide whether their recommendation to the banks to forego dividend payments and share buybacks in the corona crisis should be extended beyond the end of the year or whether it should instead switch to an institution-specific consideration. Enria’s warning words should now dampen hopes of an easing of the dividend freeze. These came up in recent weeks after leading ECB representatives such as Directors Yves Mersch and Fabio Panetta as well as France’s central bank governor Fran├žois Villeroy de Galhau had spoken out in favor of an approach more closely aligned with the respective institutes.

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