The Bank of England has warned UK lenders against reserving huge charges on sourcing loans, fearing that this will limit their ability to support troubled businesses.
BoE Prudential Regulation Authority officials have met with senior banking officials over the past week advising them not to “plan a kitchen sink” in the first quarter of the year, several people said. involved in the Financial Times.
The ARP is concerned after seeing global banks post large increases in their reserves for potential defects due to coronavirus blockages. The top six US lenders increased their first quarter loan provisions by $ 25.4 billion, an increase of 350% year-over-year. At Credit Suisse, the only European bank to report to date, the measure climbed 600%.
Banks like Barclays, HSBC, Lloyds and RBS are reporting their first quarter results for the next two weeks. If their loan loss reserves increased in line with their US counterparts, they would experience a sharp drop in profits, while Barclays would be likely to suffer a loss.
From the regulator’s point of view, the most important is that such prudent defaults planning would affect capital levels, reducing the ability of banks to take out new loans at a time when businesses are in desperate need of credit.
Supervisors have already relaxed capital and auditing rules to make sure lenders don’t eat too much in their loss-absorbing buffers. They also prohibited dividends and share buybacks to protect capital.
“Unless there is a significant increase, this will not be credible,” said one person involved in the discussions, “but the provisions should not be so massive that they absorb all the capital relief. It’s not realistic. “
The person added that the ARP had “given accounting advice to make sure that the banks did not take a mechanical approach that would gobble up all the capital that was released before it could be used.” The regulator wanted to see “a realistic, sensitive and prudent supply, which does not go too far”.
Under the new accounting rules, banks granting short-term forbearance to distressed customers would have to take larger provisions against expected credit losses.
But the central bank has stressed that, for example, not all retail customers requesting mortgage repayment are genuinely in financial trouble in the long run and therefore banks should not necessarily treat their debt as in default. Authorities have given the same advice to small businesses unable to repay their short-term loans.
At the heart of the debate are the new international accounting rules known as IFRS 9, which require banks to immediately recognize large provisions on debt sourcing, rather than waiting to suffer losses only when ‘they occur as in previous regimes.
IFRS 9 has been criticized for being “pro-cyclical” in that it exacerbates the pressure on banks’ balance sheets when they are most needed to support businesses in a crisis, in this case foreclosure. the pandemic.
One problem in implementing IFRS 9 is that there is no official BoE forecast for the depth or duration of the damage to the UK economy that banks can use as a benchmark.
Estimates range from a 6.5% drop in UK GDP this year by the IMF to a drop of 13%, according to the UK Office for Budget Responsibility.
“There is nothing close to a consensus on the GDP affected, so there is an element of subjectivity,” said a British bank president. “We can arrive at different projections and produce a justification for almost all the desired deficiencies, like the PRA. . . trying to ensure consistency of approach in this unusual environment. “
Evidence of disparate approaches is already visible in other European banks subject to the same new accounting rules. Credit Suisse increased its bad debt reserves to $ 583 million in the first quarter by seven times this week, while UniCredit in Italy reserved an additional € 900 million, a much larger increase than the same period l last year.
Indeed, the two used radically different economic forecasts. The Swiss lender sees euro area GDP fall by 5% this year, while UniCredit is preparing to drop more than double that rate.
The ARP declined to comment.