With mortgage and loan payment breaks due to expire over the next few days, the man responsible for leading the supervision of banks across Europe has said financial institutions may have to consider extending breaks to their customers.
Andrea Enria, Chair of the Supervisory Board of the European Central Bank, said such breaks have been an essential element in the response to the Covid-19 crisis.
"It is now time for banks to start becoming more active in recognising their asset quality to avoid a cliff edge effect at the end of the payment breaks, so banks need to become more active in this respect," he said.
Mr Enria said that so far, the banking sector's response to pandemic has been "fairly good".
"The European banks have entered this crisis with a much stronger capital and liquidity position, and much improved asset quality. This has enabled them to continue lending to households and businesses. That is thanks to policy measures that have been taken by the ECB and national governments," he said.
However, Mr Enria acknowledged that we are experiencing the "harshest" recession on record and said that will have an impact on banks' balance sheets.
"We ran a vulnerability analysis in July and we tried to estimate how the balance sheets of banks would develop in different scenarios. It is likely that banks will be able to manage a short-lived, deep recession like the one we are experiencing," he said.
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However, he added, "If the recovery is weaker than expected and more delayed than expected, then the impact on the banks' balance sheets will be harsher and it could lead to significant deterioration of asset quality."
He outlined what we could expect in a "severe" scenario.
"We could see up to €1.4 trillion of non-performing loans potentially generated in a severe situation, which is higher even than what we experienced in the last crisis, so we need to prepare and that is what we are urging the banks to do," he said.
In terms of preparing the banking sector for the effects of Brexit, Mr Enria said the ECB has done "everything possible" as supervisors and they have asked the banks to do all their preparations.
"We think the banks have moved significantly in the right direction and they are now ready to take the hit," he said.
Mr Enria added that despite all the preparations, Brexit will still have an impact on the banks.
"I was meeting with my team and we cannot think of anything else we could do or could ask the banks to do, but still Brexit will have macroeconomic effects on top of the Covid-19 impact," he said.
Just because we are prepared for the shock, doesn’t mean that that negative impacts won’t be there," he added.