High-earning banks set aside more Covid provisions – BIS

Loan-loss provisions taken over 2020 were “significantly higher” among banks with lusty incomes, and lower among less profitable firms, research by the Bank for International Settlements (BIS) shows.

Earnings, not capital, appeared to drive provisions across a sample of 70 large, internationally-active banks that used expected credit loss (ECL) accounting. In addition, the overall amount and dispersion of provisions taken increased in 2020 relative to the previous year. However, they also noted that in Q3, the amount of provisions fell close to Q3 2019 levels. Furthermore, six of the 57 banks that had published Q4 data at the time of the BIS research had posted negative provisions.

The researchers found that overall provisions for the sample of banks totalled $190 billion in the first half of 2020, compared with $50 billion in the second half of 2019.

 

What is it?

BIS quarterly reviews – published in March, June, September and December – explore developments in international banking and markets. Each includes a series of special features that zero in on topical issues.

Why it matters

The BIS researchers offered two possible reasons why higher-earning banks socked more away in loan-loss provisions early on in 2020 than their low-income counterparts.

First, because these banks “may have felt more comfortable” taking higher provisions that didn’t push them into a net loss position. The converse may also be true – that low earning firms believed they couldn’t set too much aside to cover future losses, perhaps out of fear the market would have punished them if their provisions exceeded net income.

Second, because high-earning banks made their money investing in high-yield, high-risk loans, which predictably required higher provisions once the coronavirus crisis struck.

The first theory was one shared by the European Central Bank in its recent Financial Stability Review. The agency suggested that the wide dispersion in set-asides taken by its supervisees could reflect “inadequate provisioning” by some banks, because of profitability concerns. 

Such behaviour might simply push today’s problems to tomorrow. After all, if a bank lowballs its provisions, then future loan losses could overwhelm their reserves, forcing them to make up the difference out of regulatory capital. This could cause even greater investor concern than a couple of quarters of negative earnings would have.

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