As the number of non-performing loans (NPLs) is expected to rise, the EU is one step ahead and had already set some guidelines that will assist banks with managing NPLs in order to keep their balance sheets strong and ensure that banks will be able to provide the more-than-ever needed liquidity to households and businesses. The growing number of NPLs is, unfortunately, no-good news for the real sector. If companies default on their loans, they will most definitely default on their trade credit.
There is no secret that the COVID-19 pandemic struck the global economy far worse than the 2008 global financial crisis. However, the effect was not the same for the banks. Most of the credit that banks are yet stable and have a strong balance sheet, can be attributed to the Capital Requirements Regulation reforms carried out after the global financial crisis in 2008. Nevertheless, banks are still to be tested as the amount of non-performing loans (NPLs) from households and businesses is expected to pile in their balance sheets. In addition, banks are expected to provide additional liquidity to borrowers through a set of public guarantee schemes and payment deferrals. As a result, banks might observe a growing amount of NPLs from the old, pre-COVID loans, and the new ones as well. The main question is how to offload the rising number of NPLs in order to provide the much-needed liquidity, and balance sheet stability in the banking sector.
The current financial health of the EU banking sector is quite promising after the shock caused by the COVID-19 pandemic according to the EU Commission (2020). Even though all of the EU member states are in a recession, the average Tier 1 capital ratio for all of the EU banks amounted to 16.4% in the second quarter of 2020. Interestingly, the average NPL ratio stood at 2.8%. For example, the NPL ratio in the EU banking sector was 2.6% in the last quarter of 2019 and 2.9% in the first quarter of 2020 according to the EU Commission (2020).
It is important to note that even though the situation looks stable now, the trend might deteriorate when government intervention and incentives will come to an end. According to the Financial Times (FT), Mr. Enria, Chair of the Supervisory Board of the European Central Bank (ECB), warned that in a severe but still possible scenario, non-performing loans in the EU banking sector could reach 1.4 trillion EUR that is well above the levels of the 2008 financial crisis. Furthermore, it is imperative to also look at the extremes when the average seems comfortable. If we have a look at Greece, the NPLs trend is also decreasing, however, NPLs still present around 39.6% of total gross loans and advances in the second quarter of 2020. The second place goes to Cyprus with the NPLs share of 14.5%.
In order to tackle the expected growth in NPLs, the EU Commission already took the incentive and provided some guidelines to efficiently tackle the potential problem. According to the Commission, the most important step is to develop a liquid, backed with quality data, secondary market for the distressed assets where banks will be able to offload their NPLs by selling them to various investors. By generating such a market, it is very important to develop a data infrastructure that will increase market transparency which will attract new investors.
Lastly, it is important to note how the growing number of NPLs will affect the real sector. As a greater number of companies will probably default on their loans, they will definitely default on their trade credit – having a severe impact on the cash flow of the creditors which is all but welcome in times of great uncertainty. Consequently, risk managers will once again be challenged to maintain stable cashflows by closely monitoring their company’s buyers in order to mitigate counterparty default risk. One of the tools that can help risk managers in managing credit risk is definitely trade credit insurance. Safe trade, predictable cash flows, up-to-date information on buyers, and time savings are only a few of the advantages of trade credit insurance.
This article was written by the team at ALPHA CREDO
Source:
The European Commission, (2020). Action plan: Tackling non-performing loans (NPLs) in the aftermath of the COVID-19 pandemic. Available here
Fleming, S. (2020). Brussels seeks to help banks offload rising tide of bad loans. Available here