Deferring loans to business? The jury is still out

A report says it’s too early to analyse the effectiveness of deferring loans.

A lot is riding on the practice of deferring mortgage and business loans in the coronavirus pandemic which, at last count, were worth about $275bn.

Amid widespread lay-offs, it made sense for banks to wait out a period of great uncertainty - and the impact of unprecedented support measures like JobKeeper and JobSeeker - before taking enforcement action against borrowers.

But what if the intuitive benefits of so-called forbearance are not borne out in practice, at least from the lender’s perspective?

A recent International Monetary Fund study of the experience of Irish banks in the financial crisis found that keeping otherwise non-performing loans alive had a range of complications.

The authors said their findings should make policymakers aware of the potential risks of forbearance in any recovery from COVID-19.

The practice was defined as restructuring loans to interest-only, which ensured there was no change in the amount owed; extension of loans by increasing the total limit or pushing back the due date; or lowering the interest rate.

Using supervisory-level data on corporate loans, the study found that banks with high levels of non-performing loans relative to their capital and provisions were more likely to grant forbearance measures to the riskiest group of borrowers.

Risky borrowers were also more likely to get an increase in the overall limit or the maturity of a loan from a distressed lender.

But importantly, there was no forbearance measure which significantly reduced the probability of default in the long-term.

Also, where banks prevented a default by granting concessions to troubled borrowers, it was often a substitute for new lending.

Terms such as zombie lending have often been used to describe the practice of making concessions to companies which are effectively on their death beds.

The IMF found this could be economically useful under some circumstances, but could also be used by banks to conceal losses.

This could lead to systemic risk by increasing uncertainty about the quality of banks’ assets and undermining trust in the banking sector’s solvency.

While the report said it was too early to analyse the effectiveness of forbearance in the COVID-19 pandemic, the implementation of broadbased measures to help companies through the liquidity shortage was justified.

“However, as disentangling illiquidity from insolvency becomes easier, our findings may help policymakers to shape a more targeted approach in later phases of the crisis,” the authors said.

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