Defaults, Non-Performing Loans (NPL) and provisioning
The following blog post is part of the overview of supervisory measures in reaction to the Corona crisis:Supervisory measures in reaction to the Corona crisis – Overview.
Since banks fear a massive wave of counterparty defaults in the course of the Corona crisis, various supervisory authorities refer to the flexibility of the current NPL framework. For example, the ECB allows banks to benefit from guarantees and moratoriums put in place by public authorities to tackle the upcoming distress in the following manner:
- Supervisors will grant flexibility regarding the classification of debtors as defaulted due to “unlikeliness to pay” when banks call on public guarantees issued in the context of the Corona crisis. Further flexibility will be exercised regarding loans under Covid-19 related public moratoriums.
- Loans which become non-performing and are under public guarantees will benefit from preferential prudential treatment in terms of supervisory expectations about loss provisioning (i.e. 0% coverage rate for the first seven years of the vintage count when determining the NPL backstop. However, the NPL backstop itself is not going to be suspended according to current discussions).
- Supervisors will deploy full flexibility when discussing with banks the implementation of NPL reduction strategies, taking into account the extraordinary nature of current market conditions.
The picture below provides an overview of the mechanism of the NPL backstop in times of the COVID-19 crisis:(please click to enlarge)
The following sub-chapters summarise the most recent publications and statements of the various authorities (especially BCBS, ECB, EBA) with regard to the prudential framework for defaulted and forborne exposures including related considerations on the provisioning according to IFRS 9.