Bad debts: ECB calls on banks to improve provisions

The European Central Bank has set an ultimatum requiring eurozone banks to improve their provisions on certain old non-performing loans (unpaid loans, bad debts). The banks concerned have just a few days to comply. If they fail to do so, the ECB will increase their capital requirements.

ECB threatens to raise capital requirements

Since the start of the Covid-19 pandemic, the European Central Bank had suspended on-site controls at bank headquarters, for example. In March 2020, the institution had also temporarily lowered capital requirements for eurozone banks, and suspended a number of operational constraints, including stress tests.

With the fear of a severe economic shock now a thing of the past, the European Central Bank is hoping for a return to normality. Last week, it announced that banks had just a few days to comply with its expectations regarding provisions for bad debts.

In concrete terms, the European Central Bank is asking eurozone banks to set aside more provisions to cover certain non-performing loans granted before April 26, 2019. Failing this, the institution will increase the capital requirements of the banks concerned.

A shortfall in provisions affecting 1 in 4 banks

At the end of 2020, the ECB had estimated a provision deficit of 13.5 billion euros. By 2021, this had fallen to 5.8 billion euros, a reduction of 7.7 billion euros. This is a relatively small amount, representing on average 0.07% of the capital adequacy ratio of the banks targeted by the ECB.

According to Elizabeth McCaul, a member of the ECB's supervisory board, only one in four eurozone banks is likely to have a provision shortfall despite the warnings. If this is the case, these banks will see their capital requirements increased during the ECB's next Supervis ory Review and Evaluation Process (SREP).

This situation will not be irreversible for the banks concerned: within a few weeks, they could see their capital requirements fall again, provided they cover their bad debts more effectively.

While bad debts have fallen considerably in the eurozone since 2014, from 1,000 billion euros to 422 billion euros at the end of September 2021, the European Central Bank remains very vigilant. Earlier in the year, the amount of these claims had been the subject of some concern, rising from 444 billion euros in December 2020 to 455 billion euros in March 2021.

In addition, the forthcoming withdrawal of certain public subsidies and the intensification of SARS-CoV-2 circulation as the year draws to a close call on the ECB to remain cautious.