The support measures of both the Government and the banks to to help to the sectors most impacted by the pandemic, such as moratoriums or shortages of ICO creditshave been essential for the survival of viable businesses. But these formulas are leaving as collateral damage a distorted view when assessing the risk of default of the new credits that are being granted now.
The key lies in the banking risk models, which, despite being validated by supervisors, may be revealing distorted results, since they are taking as a reference for the risk calculation a lack of defaults during the last two years, which constitutes an exceptional situation in which the European Central Bank (ECB) is alerting financial institutions.
More specifically, the supervisor is asking entities to urgently adapt their risk measurement models to this situation to prevent the distortion generated by the support measures implemented during the pandemic (that is, the lack of defaults) from correctly assessing the risk of non-payment of new credits. A situation that is especially relevant in the case of hospitality.
Banks use internal models to assess the risk of granting financing to their clients, that is, of the possibility of default that a certain loan has. To do this, they take into account parameters such as the customer’s past financial behavior, that is, how many times they have defaulted in recent years.
These models, despite being validated by supervisors, may be, in the opinion of the ECB, reflecting results that may be distorted, especially in the case of the sectors most affected by the pandemic. After all, they are taking into account a history in which there have been no defaults for two years, something that is far from normal behavior even without a pandemic.
In this way, if the model takes into account the credit defaults of a certain company in the last ten years, for example, and two of them are 2020 and 2021, in which there have been practically no defaults due to the measures of support, the model believes that the company has an optimal financial performance, so that it considers it a good candidate to receive new financing.
“Dyou Thirds of banks have today for new loans that give the hospitality sector a lower probability of default than in 2019. Who can believe that? Nobody, really nobody can believe it, except the model, “he explained on Thursday. Edouard Fernandez-Bollo, member of the Supervisory Board of the European Central Bank (BCE), during the XXVIII Meeting of the Financial Sector organized by Deloitte, ABC and the Appraisal Society.
Accurate but absurd
The consequence of this situation is very serious, since it may be translating into the fact that banks are giving new loans to companies that are actually unviable but that do not resemble the risk assessment model.
“This is, I suppose, mathematically exact, but it is absurd,” added the supervisor. Thus asks banks to “react” to adapt the models to this exceptional situation and do not continue to assess the risk “on the basis of a calculation as absurd as that, even if it is the calculation that is giving a validated model”.
It is, in his words, “clearly of a perverse effect of a very good thing. “” Today credits are being agreed that will be revealed at their true probability of default within several months. They could be accumulating in a completely unknown way the non performing loans tomorrow today. That is why we must immediately stop this effect of having bad indicators in themselves, not bad, but distorted, “concluded the supervisor.
This situation is clear to supervisors in the case of the hospitality industry, but it may also be happening to a lesser extent in other sectors impacted by the pandemic, such as the airlines, according to industry sources.
The representative of the ECB made these considerations on Thursday, just after Margarita Delgado, deputy governor of the Bank of Spain, will urge banks to be cautious in reversing the provisions made during the pandemic after the Spanish entities have given up the need to broaden this “protective shield” against defaults months ago.
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