European banks urged to wait and see before cutting loan loss reserves

The European Central Bank is warning banks against releasing loan loss provisions early and wants to ensure that the assumptions underlying existing provisions prove to be correct before further releases.

Banks added provisions – funds set aside to cover future non-performing loans – at the start of the COVID-19 pandemic and some began releasing them. Provisions include post-model adjustments, also known as management overlays, which are applied expected credit loss assumptions when a bank’s modeling is considered insufficient.

Some banks including Based in the Netherlands ABN AMRO Bank NV has started taking back provisions. Lenders should be “extremely careful” and avoid releasing pandemic-related provisions too soon, ECB SSupervisory board chairwoman Andrea Enria told a French newspaper The echoes in January. Regulators want banks to focus not just on individual borrower default risk but also on sector exposures as government support is reduced and inflation rises.

“The regulator is urging banks to consider ending this fiscal support,” said Osman Sattar, analyst at S&P Global Ratings. “Some groups of borrowers may be more stressed than others and may need additional support.”

Post-model adjustments

The ECB closely monitors how banks measure credit risk, including post-model adjustments, or PMAs, and has previously found that a number of banks lack justification for PMA decisions, said a central bank spokesperson told S&P Global Market Intelligence.

“Banks might start to see the need for additional provisions that LDCs don’t cover,” Sattar said.

Some major European banks have made significant additional provisions through PMAs. Spanish bank Banco Bilbao Vizcaya Argentaria SA reported that as of September 30, 2021, it had made management adjustments to its expected losses of 304 million euros. italy UniCredit SpA’s overlays amounted to €450 million for the same period. Based in Denmark Danske Bank A/S reported 6 billion crowns of post-model adjustments as of September 30, 2021, compared to 6.4 billion crowns a year earlier.

Among a selection of major European banks, Banco Comercial Português SA had the highest level of loan loss reserves as a proportion of total assets at the end of the third quarter of 2021, at 2.07%, while the Finnish bank Nordea Bank Abp had the lowest at 0.37%. In the first nine months of last year, Spain’s Banco Santander SA added the most loan loss provisions, while ABN AMRO released provisions worth 0.05% of its assets total. UniCredit, the only bank in the sample that reported results in the fourth quarter of 2021, provisioned 0.09% of total assets in the quarter, or 0.18% for the full year.

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Removal of state support, inflation

The European Banking Authority said at the end of 2021 that banks’ provisions could have been significantly affected by their failure to use the “collective assessment” method included in accounting standards, which allows groups of borrowers to be moved into a higher loan loss category if they are considered at risk by the same factors. However, banks can avoid collective assessments if they can show that they can review all loans individually.

Asset quality is expected to deteriorate with the lifting of government support programs. Inflation is also rising, which could put pressure on borrowers if it increases rapidly.

“We don’t expect a big deterioration, but we do expect a deterioration. So I expect the banks to remain cautious,” he said. Olivier Perney, head of Western European banks at Fitch Ratings.

BBVA, UniCredit and Banco Santander have the highest level of non-performing loans among major European banks, while Nordea, Danske and BNP Paribas SA are the least exposed to problem loans.

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Several major European banks have focused on reducing their stock of bad loans in recent months. UniCredit sold €222m of non-performing exposures to KRUK Group in January. Italian bank Intesa Sanpaolo SpA has cut its gross NPLs by around 34 billion euros under its current four-year business plan, which ends this month.

“Massive Overlays”

The European Banking Federation said banks bolstered their provisions with “massive overlays” at the end of 2020 ahead of expectations of a huge NPL rise that failed to materialize, so provisioning levels were very high. EffectivelyThe ECB said the average NPL ratio of supervised banks fell from 8% to 2.3% in the seven years to June 2021, continuing to fall during the pandemic.

“We understand that supervisors tend to be very conservative, but there is also a problem if a bank keeps too large provisions without long-term enforcement, and we are already two years into the hit of COVID-19,” said said Gonzalo Gasos, senior director of prudential policy and supervision at the European Banking Federation. gasos said that the banks were entitled to act according to their judgment of the economic circumstances.

“Therefore, without complacency, it is right for banks to assess with a higher degree of accuracy what future losses can be expected under generally accepted economic scenarios,” he said.

The ECB said moratoriums on state-guaranteed loans had proven effective in getting consumers and businesses through the worst of the crisis. Customers had generally resumed their payments as the moratoriums had ended.

The French government announced a new six-month moratorium on certain types of state-guaranteed loans, but moratoriums in Italy and Spain expired and loan portfolios proved resilient, Fitch said.

“There are grace periods in some countries where borrowers don’t have to pay interest or principal and these are targeted mechanisms that should help some of the worst hit borrowers,” Perney said. “So we’ll see asset deterioration, but it’s going to be very gradual.”

Nonetheless, asset quality risk could remain a key differentiator between banks, according to S&P Global Ratings.

“For some banks the question is whether they can fully release the 2020 peak in provisioning, but that partly depends on whether their economic projections support it; for others the question is how much additional provisioning is still needed,” the rating agency said. in a January 31 report.

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