Banks better involved in the crisis

Thomas huertas: simple steps on how to prevent a financial crisis from following the corona pandemic

Measures imposed to curb the spread of covid-19 threaten to stop the global economy in its tracks. Governments and central banks have initiated support programs, but they are having difficulty getting the money to the companies and some of the aid is about to expire. Both problems can be addressed by involving the banks more.

Bring money into the companies faster

First, uses banks to get money into the hands of businesses quickly, especially small and medium-sized enterprises (smes), so they can pay suppliers and cover ongoing expenses. To do this, governments should guarantee 100 percent of loans to smes and simplify the application process, as germany and the united kingdom have done. Central banks should then confirm that they are willing to accept such guaranteed loans as collateral. Banks, in turn, must integrate the granting and handling of these loans into their procedures and processes. These steps will speed up disbursement so the money can reach businesses while it can still do some good.

Secondly, it quickly becomes clear that smes need to have the option to extend maturities of loans that mature while the restrictions apply. Normally, they would have to pay a premium for it and provide additional collateral, on terms negotiated with the bank. However, there is not much time to conduct such individual negotiations. Therefore, central banks should encourage banks to do this by raising interest rates they pay on bank reserves, provided this gives eligible borrowers the right to extend the maturity of any obligations due before the end of the year.

Extending loans

Bank regulators should instruct each bank to take advantage of this opportunity and assure lenders that the maturity extension does not push these loans into the non-performing loan category and does not increase the capital requirements for loans to an unacceptable level. Collateral provided by the borrower should continue to cover existing loans and not be used to support the new government-guaranteed loan. This avoids "good" borrowers having to go bankrupt during the ongoing restrictions.

Over the next year, as restrictions are eased, government support for the economy is likely to wane. Loans under the 100 percent guarantee scheme described above must either be repaid or refinanced at market conditions. Banks should divide their loan portfolio into two categories: loans that are performing well and likely to remain so in the future, and those that are non-performing or likely to become so.

Non-performing loans

To accomplish the latter, banks need to expand nonperforming loan management and increase the staff that helps borrowers get out of debt. They should build in controls to ensure that these settlements comply with regulations. Banks did this successfully in the 2008 financial crisis, but the workouts this time are likely to be of a different magnitude and span multiple sectors. Many companies will need some form of recapitalization as part of this process so that they emerge from the crisis without a significant debt overhang.

Drawing a line under the crisis

Beyond these short-term measures, the authorities will eventually need to draw a line under the corona crisis. To this end, governments should create asset protection schemes that limit – in exchange for a premium paid by banks – the loss that banks could make on non-performing loans. In addition, governments were to create capital management companies that could work collectively on liquidation to maximize value.

Both the programs and the companies involved would have to be vetted for public interest and comply with the new state aid rules introduced to deal with the current crisis. Such a program would both strengthen banks and reduce risks to deposits and deposit insurance mechanisms. Taken together, these steps will accelerate the implementation of previously announced measures and reduce the hardship faced by borrowers. They will also help keep banks safe and stable. Preventing the health crisis from triggering a banking crisis. That would flatten the recession and revive the economy more quickly.

Thomas F. Huertas is a senior policy fellow at SAFE and a fellow at the center for financial studies.