Exit the Crisis by Restoring Bank Balance Sheet Transparency

AN ANALYSIS BY BRUNELLA BRUNO AND ELENA CARLETTI FOR THE EUROPEAN PARLIAMENT ON HOW TO PHASE OUT COVID SUPPORT MEASURES TO THE BANKING SYSTEM

European monetary authorities have been effective in deploying extraordinary measures to support the economy during the COVID-19 crisis, maintaining banks’ ability to provide companies with funds. Unwinding measures such as debt moratoria, though, might be problematic. On the one hand, a brusque stop could thwart businesses' ability to repay their debt; on the other, keeping moratoria in place for too long could mask non-temporary deterioration of a borrower creditworthiness, develop a non-payment culture also among viable borrowers and make banks balance sheets more opaque.
 
Two professors in Bocconi's Department of Finance, Brunella Bruno and Elena Carletti, co-authored with Thorsten Beck (The Business School, University of London) an in-depth analysis of the issue, on requested of the Committee on Economic and Monetary Affairs (ECON) of the European Parliament.
 
“In designing the exit strategies, restoring bank balance sheet transparency should be a first-order objective,” they write. In fact, in the case of deterioration of borrowers’ creditworthiness, prolonged relief would impair banks capability to correctly classify the risk of their loans and would increase their exposure to future risks. The quality of their balance sheets would become difficult to assess and monitor, and their capacity to loan would be reduced.
 
“Having this in mind, borrower relief measures such as moratoria should be phased out ahead of phasing out other measures, as a first important step. This is important in order to re-establish the proper screening/monitoring incentives, favor NPL recognition and, therefore, promote adequate loan loss provisioning,” the authors write. “Doing this would reduce the risk of credit misallocation (including zombification) that is likely to rise if generalized borrower relief measures are in place for too long.”
 
The second step the authors suggest is lifting the current relaxation of loan classification and provisioning policies. Asking banks to rebuild their capital buffers, thinned out in the early stages of the pandemic, should come towards the end of the exit process.

by Fabio Todesco