EBA Guidelines on legislative and non-legislative moratoria on loan repayments applied in light of Covid-19

Regulators and governments in the UK and a number of European jurisdictions have implemented a broad range of support measures for both businesses and individuals affected by the payment difficulties and liquidity shortages as a result of the Covid-19 pandemic. One of the most common measures include some form of moratorium on payment of credit obligations. Under the current CRR based rules which banks in the UK and Europe must comply with, delays in the repayment of credit obligations can trigger the regulatory definition of “default” and lead to higher own funds requirements. However, as these moratoria are adopted in different forms across jurisdictions, with some member states using specific legislation while others have implemented through non legislative means such as industry wide or institution led initiatives, there have been questions on the legal effect they have on the current regulatory capital framework, in particular the definition of default under Article 178 CRR and the classification of forbearance under Article 47b of CRR.

Similar to the PRA’s approach (discussed in more detail in our dedicated webpage) and further to its earlier statement in March, the EBA has decided to clarify the following three key issues in their guidelines on legislative and non-legislative moratoria on loan repayments in light of Covid 19: (i) the criteria that payment moratoria have to fulfil not to trigger forbearance classification, (ii) the application of prudential requirements in the context of these moratoria and (iii) ensuring consistent treatment of these measures in the calculation of own fund requirements. The EBA clarifies that institutions must continue to identify situations where short term financial difficulties may lead to long term financial problems and likely insolvency. However, this may be very difficult to do with any certainty given the lack of clarity on the length of the Covid 19 pandemic and when businesses can resume their normal operations.

Treatment of payment moratoria

The guidelines set out various criteria that a moratorium should meet in order to be considered a “general payment moratorium” to which they will apply. The conditions, which must all be met, include:

  1. the moratorium is either a legislative or non-legislative moratorium which is an industry or sector wide private initiative agreed and applied broadly by relevant credit institutions;
  2. the moratorium applies to a large group of obligors predefined on the basis of broad criteria, and while the scope of application of the moratorium may be limited only to performing obligors who did not experience any financial difficulties before the application of the moratorium, it should not be limited only to those obligors who experienced financial difficulties before the outbreak of Covid-19;
  3. the moratorium applies only to changes to the payment schedule, by suspending, postponing or reducing payment of interest or principal, but no other terms, such as the interest rate should be changed;
  4. the moratorium was launched in response to Covid-19 and was applied before 30 June 2020 although this date may be extended;
  5. the moratorium offers the same conditions for the changes of payment schedules to all exposures subject to the moratorium; and
  6. the moratorium does not apply to new loan contracts entered into after the date the moratorium was announced.
Classification of exposures under the definition of forbearance and definition of default

Where a general payment moratorium meets the “general payment moratoria” definition set out above and applies to all exposures of an institution within the scope of the moratoria, the application of the moratorium should not lead to reclassification of the exposures as forborne under Article 47b CRR unless an exposure has already been classified as forborne at the moment of application of the moratorium. Given the application of a general moratorium is not a forbearance measure, the guidelines clarify that it should also not be considered a distressed restructuring under Article 178 (3) (d) CRR. In addition, for the purposes of the definition of default and days past due criterion in Article 178, institutions should count the days past due test on the revised schedule of payments resulting from the application of any moratorium. Throughout the duration of the moratorium, institutions must continue to assess the potential unlikeness to pay of obligors and focus in particular on those borrowers for whom the effects of the COVID-19 pandemic are most likely to transform to long-term financial difficulties. Any form of credit risk mitigation such as guarantees from third parties should not exempt these assessments from taking place.

Institutions are required to collect and have information available, including clear identification of the exposures or obligors for which the moratorium was offered/was applied, the amounts that were suspended, postponed or reduced because of the application of the moratorium and any economic loss resulting from the application of the moratorium on individual exposures and associated impairment charges. These guidelines create an obligation for competent authorities and institutions to comply or explain and therefore will have a significant impact on all European (and UK) banks.

BCBS measures to reflect the impact of Covid-19

At the international level, the Basel Committee on Banking Supervision (the “BCBS”) published a paper on measures to reflect the impact of Covid-19. The BCBS agreed that the risk-reducing effects of the various extraordinary support measures taken in its member jurisdictions should be fully recognised in risk-based capital requirements.

Consistent with the approach taken by national regulators (e.g. the PRA), the BCBS has also agreed that the extraordinary support measures should be taken into account by banks when they calculate their expected credit losses (ECLs) for IFRS9. It also agreed on some amendments to the transitional arrangements for the regulatory capital treatment of ECLs. For more detail, please read the BCBS’s FAQs.