Payment holidays in the age of Covid: implications for loan valuations, market trust and financial stability

Highlights

• Governments and banks have introduced payment deferral programmes to support borrowers affected by Covid-19. But deferred payments are not forgiven and must be repaid in the future, raising prospective risks to the banking system. Thus, they should be designed to balance near-term economic relief benefits with longer-term financial stability considerations.
• The Basel Committee on Banking Supervision (BCBS) and several prudential authorities have issued statements clarifying how payment deferrals should be considered in assessing credit risk under applicable accounting frameworks. These measures aim to encourage banks to continue lending, to avert an even deeper recession.
• Prudential authorities are caught "between a rock and a hard place" as they encourage banks - through various relief measures - to provide credit to solvent, but cash-strapped borrowers, while keeping in mind the longer-term implications of these measures for the health of banks and national banking systems.
• In navigating these tensions, banks and supervisors face a daunting task as borrowers that may be granted payment holidays have varying risk profiles. Distinguishing between illiquid and insolvent borrowers - amidst an uncertain outlook - should help guide banks' efforts to support viable borrowers, while preserving the integrity of their reported financial metrics.