FRANKFURT (June 11): The European Central Bank's (ECB) top supervisory body for euro zone banking said on Tuesday that while there has been some progress in taking climate risks into account, many euro zone banks are still far from meeting accounting rules on provisions needed to protect against loan losses.
Accounting standards enacted a decade ago to avert another banking crisis require lenders to make provisions up front when they make loans and then make more thorough provisions if there are signs of default, rather than waiting until the debt goes unpaid.
But euro zone banks have been reluctant to adopt International Financial Reporting Standard 9 (IFRS 9), Claudia Buch said, reiterating concerns shared by other European regulators.
“While progress has been made, particularly in the area of climate and environmental risks, many banks are still far from meeting the expectations of IFRS 9,” Buch told the ECB conference.
The share of outstanding loans on euro zone banks' balance sheets has shrunk to its lowest since the financial and debt crisis 15 years ago, thanks in part to the ECB's pressure on its own lenders.
But surging interest rates and new geopolitical risks, from the war in Ukraine to the disruption of existing trade patterns with China and the United States, are making regulators nervous again.
Buch said banks were placing too much reliance on “overlays”, general provisions for new risks and uncertainties that are not easily captured in internal models.
As an example, Book said some banks use “umbrella overlays” that don't take into account that sectors are affected to different degrees by differences between them even if they have the same risk.
Other banks simply lowered the general forecasts of economic growth they use to calculate expected losses.
“This ignores the possibility that, for example, disruptions to trade patterns could threaten some export-oriented clients, while the impact on total GDP would be small,” added Buch, who has been head of the ECB's supervisory board since the start of the year.
“This practice underestimates the true default risk facing banks.”
Buch also said “many” banks were failing to properly reclassify loans, repeating a complaint often expressed by his predecessor, Andrea Enria.
IFRS rules envisage splitting loans into three “stages” – performing, non-performing and non-performing – based on the likelihood that the loans will not be repaid, resulting in increased levels of provisions.
“Sound risk management in banks requires improved use of overlays to more accurately consider the impact of new risks, the use of simulations and scenarios, and improved phasing,” Book said.
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