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BoE warns bank loan reserves risk choking business funding

UK financial regulation

BoE warns bank loan reserves risk choking business funding

Regulators fear conservative planning for defaults will restrict much-needed credit to companies

Britain’s financial supervisors have already relaxed capital and audit rules to ensure lenders do not eat too far into their loss-absorbing buffers © Getty Images

The Bank of England has warned UK lenders against booking huge charges on souring loans amid fears it would curb their ability to support struggling companies.

Representatives from the BoE’s Prudential Regulation Authority have spoken with top banking executives over the past week to advise them not to “kitchen sink” provisions in the first quarter of the year, several people involved told the Financial Times.

The PRA is concerned after seeing global banks post big increases in reserves for potential defaults due to coronavirus lockdowns. The six largest US lenders increased their first-quarter loan provisions by a combined $25.4bn — a year-on-year rise of 350 per cent. At Credit Suisse, the only European bank to report so far, the measure rocketed 600 per cent.

Banks including Barclays, HSBC, Lloyds and RBS report their first-quarter results over the next two weeks. If their loan-loss provisions were to increase in line with their US peers, they would suffer a sharp hit to profits, while Barclays would be likely to fall to a loss.

More important from the regulator’s perspective is that such conservative planning for defaults would hit capital levels, reducing banks’ ability to write new loans at a time when companies desperately need credit.

Supervisors have already relaxed capital and audit rules to ensure lenders do not eat too far into their loss-absorbing buffers. They have also banned dividends and share buybacks to safeguard capital.

“Unless there is a significant increase it won’t be credible,” said one person involved in the discussions, “but provisions should not be so massive that they absorb all the capital relief. That is not realistic.”

This person added that the PRA had “given guidance on accounting to make sure banks don’t take a mechanical approach that would gobble up all the capital that’s been freed up before it can be used”. The regulator wanted to see “realistic, sensible, cautious provisioning, that doesn’t go overboard”.

Under new accounting rules, banks granting short-term forbearance to struggling customers would have to take bigger provisions against expected credit losses.

But the central bank has stressed that, for example, not all retail customers who apply for a mortgage repayment holiday are genuinely in long-term financial distress and therefore banks should not necessarily treat their debt as in default. Officials have given the same advice on small companies unable to repay loans in the short term.

At the centre of the debate are new international accounting rules known as IFRS 9, which require banks to immediately book deep provisions on souring debt, rather than waiting to take losses only when they occur as under previous regimes.

IFRS 9 has been criticised for being “procyclical”, in that it exacerbates the strain on banks’ balance sheets just when they are most needed to support companies through crises, in this case the pandemic lockdown.

One problem in implementing IFRS 9 is that there is no official BoE forecast for the depth or duration of the hit to the British economy that banks can use as a baseline.

Estimates range from a 6.5 per cent decline in British GDP this year, made by the IMF, to a 13 per cent decline, from the UK Office for Budget Responsibility.

“There is nothing approaching a consensus on the GDP hit, so there is an element of subjectivity,” said one UK bank chairman. “One can come up with different projections and produce a rationale for almost any impairment number one wants, so the PRA is . . . trying to ensure there is some broad consistency of approach in this unusual environment.”

Evidence of disparate approaches can already be seen at other European banks subject to the same new accounting rules. This week Credit Suisse increased its bad loan reserves sevenfold to $583m in the first quarter, whereas Italy’s UniCredit set aside an additional €900m, a far greater increase from the same period last year.

This is because the two used dramatically different economic forecasts. The Swiss lender sees eurozone GDP falling 5 per cent this year, whereas UniCredit is bracing for a drop of well over double that rate.

The PRA declined to comment.

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