Striking a balance: bank lending in times of crisis
Frankfurt am Main, 12 August 2020
Banks play a pivotal role in financing firms and households, and thus help to promote economic growth and prosperity. Needless to say, the coronavirus (COVID-19) pandemic has seriously challenged their lending functions. As the crisis took hold, some banks found themselves overwhelmed with very high levels of loan requests, particularly when State aid programmes for state-guaranteed loans and repayment moratoria were introduced. But these banks managed to adapt quickly and helped to ensure a smooth flow of credit to firms and households.
Banks are being supported by the measures taken by the ECB to counter the effects of the crisis. For example, they are allowed to temporarily operate below the supervisory capital guidance (P2G) level and to apply the new rules on the composition of the supervisory capital requirement (P2R) early. To date, these measures have provided banks with overall relief amounting to roughly €120 billion of Common Equity Tier 1 capital. The measures appear to be supporting credit growth, too: the annual euro area growth rate of loans to the private sector has surged since February and stood at 4.8% in June 2020, up from 3.7% in December 2019.
ECB press release: Monetary developments in the euro area: June 2020
Banks are also helping the private sector to withstand short-term liquidity shocks. Since February there has been an increase in the use of committed credit lines by banks’ customers. At the same time, banks have ramped up total committed credit lines – and these are not currently being fully utilised, meaning that firms and households still have credit buffers to dip into, if needed. However, according to the July 2020 euro area bank lending survey, banks expect that credit standards for loans to firms will tighten considerably overall in the third quarter of 2020. This is related to the expected end of state guarantee schemes in some large euro area countries. Against this backdrop, the ECB encourages banks to make use of the flexibility provided by the supervisory measures to maintain their lending activities.
The impact of the current crisis has not yet led to a noticeable increase in non-performing loans: in the first quarter of 2020 the non-performing loan ratio for significant institutions stood at 3.05%, compared with 3.22% in the fourth quarter of 2019. Nevertheless, banks have built up buffers for credit losses: to cover expected credit losses, they more than doubled impairments in the first quarter of 2020 compared with the first quarter of 2019.
To form a clearer picture of the impact of the pandemic on banks’ financial soundness, the ECB has carried out a vulnerability analysis assessing the resilience of 86 banks under three scenarios. The results, which were published on 28 July, show that the euro area banking system is well capitalised and resilient enough to continue to fulfil its role of lender to the real economy. At the same time, they show that supervisors and authorities need to remain vigilant and stand ready to take further action in the event that the situation worsens. The ECB is closely monitoring the situation in close cooperation with other EU and international counterparts.
In such times of heightened uncertainty, granting credit can involve a higher level of risk. It is therefore crucial that banks apply adequate lending standards and price their loans to properly reflect underlying risks. Yet, when ECB Banking Supervision analysed the credit underwriting standards of directly supervised banks before the COVID-19 crisis, it found room for improvement. The findings of the analysis, which were published in a report in June 2020, reveal that some banks have not always paid sufficient attention to risk-based pricing while taking on higher risks in their loan books.
It is a difficult challenge for banks to perform their crucial lending function in the current situation. They need to be able to differentiate between borrowers that will remain viable throughout the lifetime of the loan and those that may not owing to the effects of the pandemic. The decisions that banks take now will have an effect on the outcome of the crisis. On the one hand, taking overly restrictive credit lending decisions will increase the likelihood of corporate defaults – leading to a deeper crisis and potential repercussions on their balance sheets. On the other hand, taking too much risk, i.e. granting loans to borrowers who may not remain viable, might endanger banks’ stability, which in turn could cause wider economic harm.
In the context of COVID-19, stable banks will be best placed to cover the financing needs of stricken households and firms to support the post‑pandemic economic recovery. Therefore, the ECB encourages banks to maintain lending to the economy while adequately managing credit risk.