EBA Guidelines on Moratoria on Loan Repayments in the Light of COVID-19

1. Introduction
   

   The COVID-19 pandemic, among its many implications, causes financial difficulties for borrowers whose loans threaten to default. To soften this blow, payment moratoria are intended to support the borrowers. However, such payment moratoria do not support the payment institutions (such as banks) issuing the loans, since although loans fall under (legislative or non-legislative) payment moratoria, they still are accompanied by increases of the bank’s own funds. The European Banking Authority (EBA) is trying to support banks in this respect.

   On 25 March 2020 the European Banking Authority (EBA) called for flexibility and pragmatism in the application of the prudential framework and clarified that, in case of debt moratoria, there is no classification in default, forborne or IFRS9 status. EBA thereby followed up its call from 12 March 2020 to Competent Authorities to make use of the full flexibility provided for in the existing regulation. In its statement dated 25 March 2020, the EBA supports the measures taken/proposed by the Member States in form of general moratoria.[1] In order to clarify which legislative and non-legislative moratoria do not trigger forbearance classification, EBA issued its Guidelines on legislative and non-legislative moratoria on loan repayments applied in the light of the COVID-19 crisis (EBA/GL/2020/02) on 2 April 2020 (the “Guidelines”).
   
   

2. Context
   

   The Guidelines must be read in context with the so-called Capital Requirements Regulation – (“CRR”)[2], i.e. Articles 47 a, 47 b and 178 CRR and supplement the EBA guidelines on the application of the definition of default under Article 178 of CRR (EBA/GL/2016/07) as regards the treatment of distressed restructuring.
   
   

3. CRR and Non-Performing Exposures
   

   CRR defines the credit institutions' (e.g. banks) own funds which are designed to absorb significant losses. The most important own funds element is the credit institutions Common Equity Tier 1 (“CET 1”) capital. CET 1 capital consists of paid-in capital instruments (which have to fulfil certain requirements under CRR) and disclosed reserves. Both parts of CET 1 must be at the immediate disposal of the bank.[3]

   To ensure a continuously sufficient amount of own funds available to absorb any losses, banks must perform certain calculations and maintain a specific ratio of own funds under CRR. By determining this ratio some of the bank’s outstanding positions must be deducted from the strict calculation of the own funds CET 1 capital.

   In these terms, according to CRR banks shall deduct (apart from other deductions) the applicable amount of insufficient coverage for non-performing exposures from their calculation of the CET 1 capital ratio.[4] Considering the minimum ratio of CET 1 capital, such deductions lead to the bank’s obligation to add additional CET 1 capital. The more additional capital the banks have to add in order to keep the CET 1 ratio, the less capital is available to spent on the market e.g. for granting loans to struggling entities.

   In order to determine which exposures must be qualified as non-performing, the CRR sets out criteria which must be taken into account. Non-performing exposures are specified by Article 47a CRR that (amongst others) takes in consideration deductions and forbearance (Stundung).

   Article 178 CRR sets the deduction criteria, whilst article 47b CRR defines forbearance as a concession granted by credit institutions when they identify that a borrower is experiencing or is likely to experience financial difficulty in repaying (a) loan(s).

   In case of payment moratoria, these criteria (i.e. deduction or forbearance) are likely to be fulfilled (e.g. in terms of the payment moratoria on consumer loans[5]).
   
   

4. Effect of EBA Guidelines on CRR
   

   The Guidelines set out that, in case of a general moratorium which meets the Guidelines' conditions, such a measure shall not change the classification of exposures under the definition of forbearance (Article 47b CRR) or change whether such measures are treated as distressed restructuring (Article 178 CRR) under CRR. This means, even though the borrower is granted a prolongation, which under strict application of CRR requirements would qualify as a forbearance measure or distressed restructuring under normal circumstances, in this case, following the Guidelines the respective prolongation does not qualify as such.[6] Hence, in this case no additional CET 1 capital must be added by the credit institution.

   4.1 Criteria for General Payment Moratoria

   Not every payment moratorium shall fall under the Guidelines. The criteria set out by the EBA on qualifying as a general payment moratorium as per the Guidelines are strictly focused on the COVID-19 pandemic e.g.:

   • The moratorium was introduced in response to the COVID-19 pandemic and was applied before 30 June 2020;
   • the scope of application of the moratorium should not be limited only to those obligors who experienced financial difficulties before the outbreak of COVID-19 pandemic;
   • the moratorium may only envisage changes to the schedule of payments (by suspending, postponing or reducing the payments of principal amounts, interest or of full instalments) for a predefined period of time and no other conditions of the loans (such as the interest rate) should be changed; or
   • the moratorium does not apply to new loan contracts granted after the date when the moratorium was announced.

   4.2 Consequence for the Financial Market

   At present, a significant proportion of the loans granted by the banks are likely to be affected by deferrals, thus qualifying as non-performing exposure under the forbearance or default definition. Since the EBA excludes such loans that are deferred due to COVID-19, this should lead to a significant relief for the credit institutions as they are not obliged to add additional capital to keep the CET 1 ratio. This means that there is more capital available to be spent on the market.

   It seems consequential that EBA does not only focus on such moratoria which are based on the applicable national law (referred to as legislative moratorium) rather than also on non-legislative moratorium schemes agreed or coordinated with the banking industry.[7] This allows a wider scope of action to be achieved since all COVID-19 related payment moratoria are taken into account, regardless of whether they qualify as legislative or non-legislative moratoria.
   
   

5. What to expect next

The European competent authorities and financial institutions must take every effort to comply with the Guidelines.[8] The German competent authority, the Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin), does already apply the Guidelines in their administrative practice, although there is no official German version of the Guidelines available yet.[9]

EBA is monitoring the processes via its Guideline Compliance Table, according to which only 4 Member States and Norway complied with before the end of April.[10]

The Guidelines are expected to increase the capital available to the banks in order to distribute it on the markets. This should lead to an increasing flexibility on granting loans to entities in need.

However, it is an economic risk to ease the CET 1 ratio, since this might lead to a situation in which the losses occurring might not be absorbed by the own funds, as an important part of these are the CET 1 capital. The EBA is also aware of this threat and therefore formulates continuous monitoring and reassessment measures, as well as documentation and notification obligations, in its Guidelines.[11]

[2] Regulation (EU) No. 575/2013, last amendment by Regulation (EU) 2019/876.

[3] Deutsche Bundesbank, https://www.bundesbank.de/en/tasks/banking-supervision/individual-aspects/own-funds-requirements/own-funds/own-funds-622952 (last visited on 6 May 2020).

[4] Article 36 paragraph 1 literature m CRR.

[5] Art. 240 paragraph 1 of the German Introductory Act to the Civil Code (EGBGB).

[6] Section 11 Guidelines of EBA/GL/2020/02.

[7] Section 10 literature a Guidelines of EBA/GL/2020/02.

[8] Section 1 of EBA/GL/2020/02.

[9]https://www.bafin.de/SharedDocs/Veroeffentlichungen/DE/Meldung/2020_Corona_andereBehoerden/meldung_2020_04_03_corona_virus34_EBA_Leitlininien_Zahlungsschuldenmoratorien.html?nn=13831544 (last visited on 6 May 2020).

[10] https://eba.europa.eu/regulation-and-policy/credit-risk/guidelines-legislative-and-non-legislative-moratoria-loan-repayments-applied-light-covid-19-crisis (last visited on 6 May 2020).

[11] See Sections 14-17 of EBA/GL/2020/02.