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European Central Bank Prepares for Increased Credit Risk

Central Banks
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EDITOR NOTE: What this article is essentially trying to convey is that the European Central Bank screwed up in their initial assessment of credit risk during the pandemic. They’re now stepping up their efforts to scrutinize credit risk among banks, fearful that once government stimulus runs out, there’s going to be a wave of defaults that’ll end up collapsing their banking system. When we published our Bank Failure Survival Guide, some readers may have been a bit skeptical, assuming that certain risks were commonplace (read: manageable) and that “tail risk” (severe risks that occur on the extreme end of probability or frequency) seemed far-fetched. This was before the pandemic. And now, look at where the global economy sits--at the edge of a precipice. You see, it’s not that we can “predict” such tail risks, it’s more like tail risks happen more often than most people would like to think. US banks are reporting outstanding earnings, mainly due to trading profits. Their risks, occupying a separate category altogether, have not disappeared. And in case US banks end up facing the same fate as those in the Eurozone, you may want to pick up a copy of our survival guide to prepare yourself should our banking system, too, begin to fail.

The European Central Bank is stepping up its scrutiny of credit risk at banks across the continent to get a better sense of their preparation for a potential wave of loan defaults triggered by the pandemic.

Officials from the ECB and national watchdogs are pushing lenders including BNP Paribas SA, Societe Generale SA and Deutsche Bank AG for additional information on their corporate lending in 2020, people familiar with the matter said. It’s part of an effort to ensure that lenders can withstand a possible surge of defaults, they said, asking not to be named discussing a private matter.

ECB Supervisory Board Chairman Andrea Enria has repeatedly warned that the pandemic may cause non-performing loans at banks to soar once government relief programs run out, and has urged lenders to brace for that scenario. He’s also expressed concern about the different methods banks are using to account for credit risk and provisions.

An ECB spokeswoman declined to comment on individual banks, referring Bloomberg to a letter written by Enria in December in which he urged lenders to accurately monitor the build-up of bad loans. Representatives for BNP, Societe Generale and Deutsche Bank declined to comment.

“Investors have been left scratching their heads about the disparity of loan loss provisions across banks,” Osman Sattar, an analyst at S&P Global Ratings, said in an interview earlier this month. During the upcoming earnings season, “they’ll be looking at whether banks that didn’t have big upticks in provisions will be playing catch-up.”

Ten of Europe’s biggest lenders probably set aside another $15 billion for doubtful credit in the fourth quarter, according to analyst estimates compiled by Bloomberg. By contrast, many of the top U.S. banks bolstered profit in the period by releasing reserves made earlier in the year.

The ECB is undertaking a series of actions to ensure banks’ capital cushions are strong enough to withstand a severe economic blow. While it continues to constrain dividends and bonuses, the ECB is also considering tighter capital requirements for banks that don’t adequately manage their leveraged finance risks.

The ECB is “challenging” banks on how much risk they want to take in leveraged loans and how they stress test their holdings, executive board member Frank Elderson told the European Parliament on Monday. The supervisor “will not shy away” from slapping higher capital requirements on banks if they’re found to be deficient.

Originally posted on Yahoo! Finance

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