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Covid-19 – Impact on the banking industry

Covid-19 – Impact on the banking industry

The current crisis has materially reduced the creditworthiness of banks’ credit customers across an array of business areas. After all, a person who has lost his or her job or is not generating any sales as an entrepreneur will often no longer be able to repay his or her loans. 

Austrian legislators are attempting to defuse this situation in certain areas by using the Covid acts to provide relief in various forms. In fact, parts of these acts are also aimed at the relationship between banks and borrowers. The measures taken so far, however, do not do much more than “postpone” the problem. 

Overcoming the credit crisis that is now looming as a result of the health crisis will require yet more considerable efforts on the part of the government to ensure the stability of the financial system. 

Statutory deferral of interest and redemption payments 

In order to relieve the burden on households and small businesses during the crisis, Article 37 of the Fourth Covid Act ordered the due dates of payment obligations under credit agreements concluded between banks and consumers or micro-enterprises before 15 March 2020 to be postponed. In line with this, lenders’ claims for interest or repayments due between 1 April 2020 and 30 June 2020 will be deferred for a period of three months from the due date if the consumer in question has lost income due to Covid-19, and as a result of these losses, it would be unreasonable to expect them to render the service owed. The postponement period also comes into play if the entrepreneur cannot provide the service or can only do so at the risk of jeopardising the economic foundations of their business. 

The legal consequence of the statutorily ordered deferral is that, during this period, borrowers are not deemed to be in default if the contractually owed amounts are not paid, no interest is incurred on arrears and terminations are not possible until the deferral expires. In addition, during the deferral period, the bank shall be obliged to give customers the chance to discuss the possibility of an amicable settlement and possible support measures. If the bank and the customer do not reach an amicable settlement for the period after 30 June 2020, the contractual period shall be extended ex lege by a further three months. At the same time, the due date of contractual services is also postponed by the duration of this period. Further relief was provided for loan agreements entered into before 1 April 2020 if the debtor’s economic capacity is significantly impaired as a result of Covid-19. 

Relief for customers from the banks’ perspective 

Pursuant to § 39 of the Banking Act, banks are required to obtain information on risks relating to their business and operations and to manage, monitor and limit these risks by means of appropriate strategies and procedures. The credit business is subject to extensive regulations which mean banks must constantly monitor the default risk posed by their customers. If the risk situation deteriorates, this results in operational obligations to act vis-à-vis borrowers, as well as internal consequences for the management of credit commitments, such as intensive support, the processing of problem loans and the creation of risk provisions. Irrespective of the statutory deferral, this means that banks need to adjust their rating systems and the estimated probability of default to align with the current crisis and create appropriate value adjustments for anticipated defaults on loans, in accordance with the Austrian Commercial Code or the IFRS. In turn, this may have an impact on the banks’ capital base under banking law. In accordance with IFRS 9, whether Covid-19 has significantly increased the credit default risk is of major importance. This requires a holistic assessment of various qualitative and quantitative indicators over the expected remaining term of the commitments in question. 

On the one hand, the state stabilisation measures that have been introduced, such as subsidies, government guarantees and the like, will play a significant role in this assessment. In individual cases, these may well be enough to get a household or small business through the crisis. On the other hand, this support is not exactly generous, and it is precisely the aforementioned deferrals that can have the effect of hitting crisis-ridden households all the harder when the deferral expires, as a result of the payment obligations that have been accumulated. 

This is then even more likely to lead to insolvency, albeit belatedly. Therefore, while ESMA and IASB stress that a statutory deferral is not in itself enough to achieve a quasi-automatic downgrade of the affected loans in the banking risk systems, the crisis will undoubtedly cause far-reaching economic problems for borrowers in practice, and bring with it the potential that banks’ balance sheets will be devalued in line with this. The deferrals may well temporarily help borrowers to make ends meet during the lockdown, but this does not provide a real solution to the debt problem. 

Administrative simplifications for companies 

For companies, the various Covid acts have so far provided relief, as far as financial matters go, in connection with the preparation (§ 3a Covid-19 Act) and disclosure (Art. 21 § 2 of the Second Covid-19 Act) of annual financial statements. Previously, there was an obligation to file for bankruptcy within sixty days of the occurrence of insolvency if the conditions for bankruptcy (articles 66 and 67 of the Insolvency Code) were met, but art. 22 of the Second Covid-19 Act also extended this period to 120 days provided that these conditions were grounded in the Covid-19 epidemic. 

In contrast, a legal moratorium on loan interest and redemption payments had not been created for entrepreneurs (except micro-entrepreneurs) by Easter 2020 (i.e. the date when this article was completed). The crisis may potentially have a negative impact on companies’ relations with banks, even for those that are liquid in themselves, simply as a result of its very existence. This is because loan agreements in the commercial sector often contain clauses pursuant to which the occurrence of “significant negative developments” on the market is already defined as an event of default. 

An event of default of this nature can then lead to the acceleration of the loan through early termination by the lender. In turn, this can lead to the offsetting of an early repayment penalty, depending on the circumstances, and subsequently to the cross default of other (additional) loan relationships. As a result, even if companies are able to repay at current lending rates, the crisis could put them in difficulties that threaten their very existence in terms of the early repayment provisions contained in standard loan agreements. 

To date, these circumstances have barely been taken into account under Austria’s Covid-19 legislation. Apparently, legislators are relying on the fact that banks will generally have no interest in going for the nuclear option with the companies in question, simply for reasons of self-protection. And indeed, in practice, it may well be the case in many sectors that banks are able to reach decisions that safeguard borrowers’ economic survival, while also taking into account the interests of the bank. 

The health crisis could be followed by the credit crisis

However, despite all the (very justified) confidence in the pragmatism and economic expertise within both banks and companies, there can be no doubt that the Covid-19 crisis has the potential to cause very serious equity issues for Austria’s banks, in view of the strict rules contained within the Banking Act and the CRR. Europe’s recession that has accompanied the crisis will inevitably lead to an increase in bankruptcies, which, in turn, will have a negative impact on the rating of the companies that manage to make it through (or managed it so far). The associated write-downs in banks’ balance sheets, and the simultaneous increase in capital requirements for the remaining portions of the loan portfolio, are likely to result in the lending criteria for new loans being tightened up even further. Experience shows that the shortage of equity capital will lead to difficulties in providing follow-up financing as a consequence – at a time when companies are particularly dependent on liquidity inflows. This means that a negative credit spiral is looming, further dragging the economy down. 

As was the case during the last global financial crisis, the Austrian banking industry is once again at risk of a stability crisis. In contrast to 2008, this time around, the economic problems experienced by households and the real economy that have been triggered by the health crisis would spill over to the financial sector in a second wave. It is by no means certain whether European banks will be able to cope with this credit crisis: they have been fundamentally strengthened since the financial crisis but are still vulnerable, and there is no doubt that the crisis will hit if additional statutory support measures are not taken. 

Consequently, the supervisory authorities FMA and OeNB, in agreement with the ECB, should address the problems in a manner tailored to each individual bank at an early stage and work with legislators to find a solution that will keep the Austrian financial system stable, even after Covid-19. In this respect, the deferral arrangements adopted for small loans to date are probably rather cosmetic in nature, even though they might at least temporarily ease the burden on consumers, given the potential scale of the balance-sheet problems that the lending industry is facing. 

Associate Professor, MMag. Dr. PHILIP GOETH, LLM (LSE), barrister (England & Wales), chartered accountant, tax consultant (Austria) and Of Counsel at LANSKY, GANZGER + partner

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