Finance: Research, Policy and Anecdotes

Banking and COVID-19: recurring themes

Last week, I participated in three virtual panel discussions on banking and COVID-19, twice as moderator and once as speaker.  One of the events was organised by the Florence School of Banking and Finance in cooperation with European Economy, with the latest issue featuring lots of interesting papers, including one by yours truly, a second event by CEPR-SAFE and a third by the Financial Risk and Stability Network. Several themes came up again and again; in the following I will elaborate on some of these (important to stress that even if there are references to specific people, all opinions are my own:


The presentation by Andrea Enria pointed to a discrepancy between optimistic market expectations on banks’ profitability and asset quality and a more sceptical supervisory assessment, where the latter, however, is still to be confirmed with the on-going stress tests.  Why such a discrepancy? While the macroeconomic perspectives certainly look bright (the projections by the European Commission point to GDP reaching pre-pandemic levels in 2022), leverage has gone up across the corporate sector; further reallocation needs will result in non-performing loans; as borrower relief measures expire or are phased out, there is potential for concerns. One important feature, however, will be the uneven recovery across countries, also exacerbated by different starting points before the crisis. There has been a lot of talk of a K-shaped recovery; this relates not only to cross-sectoral differences but also differences across countries (partly driven by different sectoral composition). Obviously, this links to fiscal support for the recovery phase, which might be also uneven across countries, exacerbating divergences. While fiscal policy was not the focus of any of the three panel discussions, it always lurks in the background.


Corporate overindebtnedness can result in both zombie lending and non-performing loans (NPLs), effectively two sides of the same coin. Not recognising and resolving NPLs swiftly can result in zombie lending, with negative repercussion for economic recovery and long-term growth. However, banks have to be given the right incentives and tools to do so. Returning to standard loan classification and provisioning rules is a critical part; asset quality reviews and stress testing another. At the same time, deficiencies in corporate insolvency frameworks have to be addressed. However, with a large number of non-performing borrowers, even this might not be enough, which brings us to the potential role of asset management companies taking over large number of NPLs.


Asset management companies (AMCs) can exploit economies of scale in the workout of non-performing assets and help close the gap in pricing, when asset prices are temporarily depressed. AMCs might also be in a better position to restructure the debt of borrower with multiple bank relationships and – by taking on a coordination role – avoid fire sales that result in a further depression of asset prices. At the same time, being able to off-load non-performing assets allows banks to focus on lending to performing and new borrowers.  While in theory, similar effects can be achieved through market-based securitisation schemes, asymmetric information between banks and investors (resulting in a lemons problem) and the more urgent need for banks to offload assets than for investors to buy might result in market failures, in addition to absorption limits of private markets. Public-private partnerships, where publicly-supported AMCs are partly funded by private investors, seem a more promising route.   The more successful AMCs, including after the Global Financial Crisis in Ireland and Spain, however, have dealt with real estate rather than with SME loans, which are more heterogeneous, complex and costly to work-out.


An uneven recovery and thus incidence of corporate insolvency and thus NPLs will also result in variation in bank fragility across countries. One important topic that was discussed is whether the current bank resolution framework is fit for purpose in the case of systemic fragility. There seems an increasing consensus that it might not be enough and that additional tools and mechanisms might be needed (including the above mentioned AMCs, though they are subject to rather strict, maybe too strict, state aid conditions).  Of course, there is a broader question on the extent to which authorities should rely on bail-in and possibly liquidation or on taxpayer support to limit the negative externalities of bank failures.   Christian Stiefmüller from Finance Watch was part of one of the panels – the motto of Finance Watch is to “making finance serve society”; there is an obvious trade-off, however: closing too many banks might undermine the economic recovery; bailing banks out, on the other hand, sends strong and possibly wrong political signals about the privileged position of bankers (apart from setting wrong moral hazard signals).


Applying strict bail-in rules in the context of bank resolution relates to the broader question of restructuring the European banking system and reducing the bank-bias in Europe’s financial system. However, it also relates to a possible re-emergence of the bank-sovereign link that featured so prominently during the Eurodebt crisis. Only a completion of the banking union and a move away from national banking systems can prevent such a re-emergence.  Fostering cross-border mergers in the context of banking restructuring can be one important dimension. If there is the perceived need for taxpayer support, any such resources should be clearly linked to overarching objective or restructuring and Europeanising Europe’s banking system.


One important barrier when addressing the problems of Europe’s banking systems is the close links between politicians and bankers, on the local, regional and national level. There will certainly be political resistance against the necessary restructuring if not retrenchment of banks. One can only hope that there will be some political leaders courageous enough to hold against these pressures.