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Law360, London (June 4, 2020, 3:00 PM BST) -- British banks must hand over estimates of the hit they expect to take from loan defaults, the Bank of England said Thursday, as it works to calculate the toll of the coronavirus pandemic on the U.K. economy.
Sam Woods, chief executive of the Prudential Regulation Authority, called on banks and building societies to provide estimates of their loan losses ahead of financial companies reporting their second quarter results.
The central bank's financial policy committee has already used a "desktop stress test" to estimate that £80 billion ($100.4 billion) in credit losses will weigh on the sector by the end of 2021. But the exercise was a prediction, rather than a forecast, that did not draw on submissions from banks, Woods said.
The PRA, the central bank's regulatory arm, is therefore asking banks and building societies to provide estimates so it can compare the scale of losses that the committee has modeled with those anticipated by banks.
"This information will enable us to identify any significant outliers and to further refine our estimates for future capital exercises," Woods said in a so-called Dear CEO letter to chief executives of U.K. banks and building societies dated Thursday.
Britain is facing its worst recession in 300 years as a result of businesses being shut and employees being furloughed during the crisis. The central bank is trying to quantify how much loan defaults will cost the economy, as these are set to rise when payment breaks start coming to an end.
The U.K. has introduced payment holidays on mortgages and other loans to help business and individual borrowers during the pandemic. The first set of three-month payment freezes, which were approved in April, are due to end soon.
Woods also set out guidance on Thursday for banks on how to reflect on their balance sheet loans that are no longer subject to the initial payment deferral period. He told lenders that loans that were subject to a payment holiday do not necessarily need to be categorized as being a credit risk, while loans that are not in arrears may actually be risky.
"Firms will therefore need to make holistic assessments that look beyond past-due information and use of payment deferrals in order to treat such loans appropriately for accounting and regulatory purposes," Woods told lenders on Thursday.
Woods guided banks in March on how to reflect loans that have not been repaid by customers in their accounts, in a bid to help them interpret a 2018 accounting standard, known as IFRS 9. He told lenders at the time that they should make "well-balanced" decisions on how much cash they expect to lose, taking into account relief measures already announced by the government and BoE.
International Financial Reporting Standard 9, published by the International Accounting Standards Board, forces financial companies to recognize financial losses from permanent hits to their assets, known as impairment losses, at an early stage. But banks fear they will be forced, by the global accounting rules, to set a large amount of money aside to deal with the fallout from the coronavirus.
--Editing by Rebecca Flanagan.
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