Banks in the European Union have the flexibility to avoid a huge rise in provisioning for temporary non-payment of loans during the coronavirus outbreak, EU banking and securities watchdogs said today. 

Banks said they face mounting provisions, which could eat into their capital, as business and households struggle to repay loans because of disruption caused by Covid-19.

EU states have offered some relief to businesses such as repayment holidays on loans or state guarantees on the loans. 

But banks have been unsure whether payment holidays and similar measures would still technically constitute a failure to pay, triggering a requirement for increased provisioning under a global accounting rule known as IFRS 9. 

European Securities and Markets Authority (ESMA) said the IFRS 9 "includes sufficient flexibility to faithfully reflect the specific circumstances of the COVID-19 outbreak and the associated public policy measures." 

Banks should distinguish between a risk to the whole life of a loan and measures to address "temporary liquidity constraints on borrowers", the watchdog said. 

The Association for Financial Markets in Europe (AFME), a banking industry body, said ESMA's clarifications were helpful and would help banks provide relief for customers. 

The European Banking Authority (EBA) told banks to distinguish between borrowers whose credit standing would not be significantly affected by coronavirus in the long term and those unlikely to be creditworthy after the epidemic. 

"The EBA calls for flexibility and pragmatism in the application of the prudential framework and clarifies that, in case of debt moratoria, there is no automatic classification in default, forborne, or IFRS9 status," EBA said.