Challenges and Opportunities for Commercial Banks in the Conditions of State of Emergency

Banks are one of the main pillars of economy in ordinary circumstances and even more so – in the crisis caused by the measures undertaken by the State for limiting and slowing down the spread of COVID-19. The emergency measures have the banks facing new challenges. They will have to achieve ambitious results under the new conditions – to offer the State the necessary support by protecting the threatened economy from collapse, to undertake the necessary actions to protect their clients – depositors and borrowers, and at the same time to meet the capital adequacy and risk management requirements.

Following the 2008 crisis, capital adequacy requirements were increased. Banks are required to have contingency plans and business continuity plans that ensure the ability to maintain operations and limit losses in the event of a major disruption. The stress tests conducted so far prove the stability of the banking system in Bulgaria.

According to the Measures and Actions during the State of Emergency Declared with a Decision of the National Assembly from 13 March 2020 Act, until the state of emergency is lifted, the consequences of late payment of the obligations of private persons shall not arise, including interest and penalties for delay, as well as non-monetary consequences such as the right to demand early repayment, termination of contract and seizure of property. These provisions were supplemented by the amendment of the law promulgated on 9 April 2020 in State Gazette No. 34, stating that in the event of late payment of obligations of private entities, debtors under credit agreements and other forms of financing (factoring, forfeiting and others), provided by banks and financial institutions under Art. 3 of the Credit Institutions Act, including when the receivables are obtained from other banks, financial institutions or third parties, and under leasing contracts, no interest and penalty interest shall be charged, the obligation cannot be declared due early, the contract cannot to be cancelled due to default, and no items can be seized.

The law also regulates the suspension of all announced public sales under the Civil Procedure Code, as well as entries into possession. No attachments to the bank accounts of natural persons and medical establishments may be imposed, and no inventories of movable and immovable property of natural persons may be taken, except for maintenance obligations, for damages and for claims against wages and salaries. There are no specific provisions suspending or cancelling sales in bankruptcy proceedings. In order to follow the requirements of the quarantine measures, in practice the scheduling of upcoming sales before the end of the state of emergency should be avoided.

The consideration of civil and commercial cases is postponed, and a number of procedural time limits and limitations periods are suspended.

The provisions listed above impact the banks’ abilities to collect their claims. What is more, the collection of claims is postponed indefinitely.

In the current situation banks are evidently facing real challenges, one of which is the expected rise in non-performing loans and the slowdown in collection. Against this background, governments and central and commercial banks are taking joint actions to preserve the stability of the economy and of the banking system and to protect the borrowers from ruin. Banks remain open for business and continue to provide all services they usually provide, while complying with safety and security regulations. There are discussions to suspend or postpone bank loan payments and to introduce a moratorium on loans.

On 25 March 2020 the European Banking Authority (EBA) published a statement, available on its website, regarding the measures taken by governments to limit the spread of the pandemic, including through a potential moratorium on loan payments. The EBA called for flexibility and pragmatism in the prudential framework and in the application of supervisory approaches to capital adequacy requirements. According to the EBA, when announcing a possible moratorium on payments, loans should not be automatically classified as overdue and the adverse effects of overdue payments should not automatically occur. It is recommended that in each case an adequate risk assessment should be done and it should be evaluated whether the borrower can continue to make payments. Consumer protection remains a priority and financial institutions should ensure full disclosure and act in the interest of customers, with no hidden charges or automatic impact on credit ratings. The EBA recommends that loans should be renegotiated in such a way that banks’ financial standing is not impaired.

On 31 March 2020 the EBA published a new statement on the activity of banking systems in the face of the measures for containing COVID-19. The EBA clarified its expectations regarding dividend and remuneration policies. It notes that measures taken should guarantee that banks maintain a sound capital base and provide the needed support to the economy. The EBA emphasized that any capital relief resulting from the measures taken by the competent authorities in response to the COVID-19 crisis should be used to finance the corporate sector and households, not to increase distribution of dividends or share buybacks. The Authority also stressed the need for an efficient and reasonable allocation of capital to banking groups. According to the EBA, the allocation of capital within a banking group should serve the need to support local and wider European economies, as well as ensure the proper functioning of the European single market, which is particularly important in the current crisis period.

EBA underlined that banks should review their remuneration policies and practices to ensure that they are consistent and to promote sound and effective risk management in the current economic situation. It stated that remunerations, especially in their variable part, should be set conservatively and that the payment of most of these remunerations could be deferred for a longer period and that a larger portion could be paid in the form of equity instruments.

The EBA reiterated its support for all the measures taken so far to ensure the sound capital base of banks, which is necessary to support the economy. It reiterated and expanded the call to abstain from dividend distribution or share buybacks for the purpose of remunerating shareholders. It called for remuneration policies to be assessed in line with the risks posed by the economic situation. Similar calls have been made by other banking supervisors, including the European Central Bank, which in its bailout program has lifted restrictions on the purchase of bonds.

The EBA indicated that efforts should be focused on monitoring and assessing the impact of the COVID-19 epidemic, as well as ensuring business continuity. It pointed out that, given the situation, the submission of the necessary reports and data to the supervisory authorities should be extended over time, taking the necessary measures to prevent unauthorized persons from accessing crucial information.

The EBA also provided further guidance on how to use flexibility in supervisory reporting and recalled the necessary measures to be taken by banks to prevent money laundering and terrorist financing. It stressed the importance of building and maintaining effective systems and controls to ensure that the European Union’s financial system is not used for money laundering and terrorist financing.

The EBA indicated that it is important to have key prudential information on capital, risks, liquidity and financial standing.
In connection with its statement from 25 March 2020 and in coordination with the Basel Committee on Banking Supervision, the EBA decided to cancel the quantitative impact study based on the June 2020 data.

These guidelines need to be taken into account when implementing measures at the national level. The Bulgarian National Bank has repeatedly stated that the financial system in the country is stable and that efforts are being made to upgrade and implement measures in response to the new situation. Short- and long-term measures are being developed, as the sector prepares to face the coming economic crisis and be part of the solution. The Bulgarian National Bank has taken a package of measures to curb the negative effects of the crisis. These measures should ensure the smooth functioning of the monetary regime, strengthen the capital and liquidity base of commercial banks and ensure that there are regulatory measures in place that give greater flexibility to commercial banks in alleviating the negative effects of the crisis on their business and household customers.

On 2 April 2020 the EBA published its Guidelines on treatment of public and private moratoria in light of COVID-19 measures (the Guidelines).

The Guidelines were issued pursuant to Article 16 of Regulation (EU) No 1093/2010 of the European Parliament and of the Council of 24 November 2010 establishing a European Supervisory Authority (European Banking Authority), amending Decision No 716/2009/EC and repealing Commission Decision 2009/78/EC. The aim is to ensure the common, uniform and consistent application of European Union law throughout all Member States.

In accordance with Art. 79a of the Credit Institutions Act, the Bulgarian National Bank complies with the guidelines, recommendations and other measures adopted by the EBA, and provides all necessary information for the execution of its duties under the terms of Regulation (EU) No 1093/2010 of the European Parliament and the Council.

On 3 April 2020 the Board of Directors of the Bulgarian National Bank adopted a decision stating that it would comply with the Guidelines of the European Banking Authority, which were published on its website. Based on these Guidelines, the BNB instructed commercial banks to propose, within five working days, a single draft on rules for private moratorium on bank loan payments.

The Guidelines of the EBA from 2 April 2020 lay down requirements for moratoria on loan repayments. They confirm what was previously asserted in the statement from 25 March 2020 that if a moratorium is implemented, the adverse effects of overdue payments should not automatically occur and that loans should not be automatically classified as overdue. The Guidelines provide that a moratorium on payments should not lead to the categorization of exposures as non-performing, if the measures are based on national legislation or on a private initiative for the entire banking sector agreed and offered by the relevant credit institutions.
The common element of the measures undertaken by Member States is that they all provide for a payment relief for obligors affected by the COVID-19 pandemic by allowing suspension or postponement of payments within a specified period of time, allowing the obligors to return to regular payments after the situation is back to normal.

The EBA stresses that given the situation, it is particularly important to ensure that the risks are identified and measured in a true and accurate manner. The Authority notes that individual assessment should be performed for each case and that a distinction should be made between situations where there are short-term payment challenges and situations where short-term payment challenges may transpose into long-term financial difficulties and eventually lead to insolvency.

The EBA insists that different cases should be correctly classified, so that the capital adequacy of banks is not disrupted.
In order to achieve consistent application of the measures across Member States, the EBA has provided clarifications as to the definition of default under Art. 178 of Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012 in view of the specific situation arising from the restriction of COVID-19.

The clarifications of the EBA are in line with Article 178 of Regulation (EU) No 575/2013, with Commission Delegated Regulation (EU) 2018/171 on the materiality threshold for credit obligations past due and with the EBA Guidelines on the application of the definition of default under Article 178 of Regulation (EU) No 575/2013.

The Guidelines prescribe that the measures undertaken by banks should be specific to the circumstances – the financial circumstances of the borrower and the loan agreement, with the aim of helping borrowers who are experiencing temporary difficulties. Banks should carry out an individual assessment of the repayment capacity of the borrower and grant forbearance measures tailored to the specific circumstances of the borrower in question.

The EBA further notes that where institutions do not apply any general payment moratoria, but instead apply some form of individual measures and renegotiate the loans taking into account the specific situation of individual obligors, they have to assess whether such individual measures meet the definition of forbearance in accordance with Article 47b of Regulation (EU) No 575/2013, as amended by Regulation (EU) 2019/630. The EBA clarifies that in such cases there is no automatic reclassification of the exposures, but this would be based on individual assessment. The existence of indications of default in accordance with Art. 178(3) of Regulation (EU) No 575/2013, as amended by Regulation (EU) 2019/630, should be taken into consideration.

The general conditions as concerns payment moratoria are the following:

The moratorium must be launched in response to the measures imposed to restrict the COVID-19 pandemic. The scope and time of application of the guidelines of the EBA are limited and they apply only to specific measures taken in response to the current economic situation caused by the measures taken to limit the COVID-19 pandemic, and the moratorium must be announced and applied before 30 June 2020. The Guidelines from 2 April 2020 also apply to moratoria imposed before the Guidelines were issued. The EBA notes that if necessary, depending on the further developments, this time limit may be extended at a later point in time.

According to the EBA, the moratorium has to be broadly applied, whether it is legislative or non-legislative, and to apply to a broad scope of debtors, in order to ensure that the change in the payment scheme does not address the specific financial difficulties of particular debtors. It is necessary to apply uniform standards to the different groups of borrowers. The selection criteria should be broad enough and not limited to a specific exposure class, specific product range (for example, mortgage loans only) or debtors from certain regions or specific sectors of the industry.

EBA indicates that a moratorium cannot be imposed only on certain groups of debtors on the basis of their ability to repay their loans.

The moratorium is optional for debtors. They may file applications that they are affected by the COVID-19 restriction measures and request that they take advantage of the opportunities offered by the moratorium.

The moratorium leads to suspension of payments – of the principal, interest or both, within a limited period of time. This may lead to increased payments after the period of the moratorium or an extended duration of the loan. The EBA points out that the moratorium should not affect other conditions of the loan, such as the interest rate, unless such change only serves for compensation to avoid losses which an institution otherwise would have due to the delayed payment schedule.

The moratorium does not apply to new loans granted after the launch of the moratorium. Banks can extend new loans by assessing payment options. The granting of loans to old and new clients during the moratorium is encouraged, in which case normal credit policies should be followed and the ability of borrowers to settle their obligations should be considered.

The Association of Banks in Bulgaria proposed to the Bulgarian National Bank a draft of Terms for deferring and settling payable obligations to banks and their subsidiaries – financial institutions with regard to the state of emergency, introduced by the National Assembly on 13 March 2020.

On 10 April 2020 the Management board of the Bulgarian National Bank approved the proposed draft. The approved Terms for deferring and settling payable obligations to banks and their subsidiaries in effect is a private moratorium under the Guidelines of the European Bank Authority.

Commerce banks shall publivly declare at their websites and their office the terms for deferring and settling obligations.
The approved private moratorium provides the opportunity to change the schedule for payment of the principal debt and/or the interest, without changing the general parameters of the credit contracts, e.g. the interest rate.

It is possible to defer obligations until 31 December 2020, if the respective contract has been concluded before 31 March 2020. The necessary condition is for the clients to have explicitly stated before their bank, that they wish to utilize the option for deferring the obligations and to have observed their obligations regularly or with no more than 90 days delay until 1 March 2020. The end date for deferring the obligations can vary depending on the date, on which the client requested to utilize the deferring, and on the existence of delayed installments up to the same date.

The following three standardized mechanisms are provided:

  • Mechanism No 1 – deferring principal debt and interest for up to 6 months;
  • Mechanism No 2 – deferring principal debt for up to 60 months;
  • Mechanism No 3, applicable for revolving products.

The respective mechanism shall be chosen via consent between the banks and their clients.

The sums which are not paid at their initially negotiated maturity shall be paid in installments after the deference period (free period) expires, in accordance with the chosen deference mechanism, unless stated otherwise in the applicable mechanism.
Deference can be requested by each client, who meets the requirements, but no later than 22 June 2020, and the creditor must reach a decision until 30 June 2020.

The request must contain unpaid obligations, as well as obligations, the maturity of which has not expired yet. If at the date of filing the application the client is not in arrears, the deference shall apply only for the installments with future maturity.

The client can refuse the provided deference period sooner than provided for and to request the drafting of a repayment plan.
The Terms for deferring obligations is drafted by the Association of banks in Bulgaria. Each bank, which decides to implement it, shall have to file an application signed by the bank’s representatives before the ABB. The list of the banks, which have filed such applications, shall be provided by the ABB to the Bulgarian National Bank.

The terms of the moratorium apply also to financial institutions, which are subsidiaries of banks.

Outside the scope of the terms approved by the Bulgarian National Bank, creditors can negotiate individual deference plans, different from the aforementioned, with their clients, including other relief measures. In such cases the banks shall not be able to utilize from the temporary principle, introduced via the adopted moratorium and following the guidelines of the EBA, that the deference or relief does not result in reclassification of the exposition under the terms of restructuring or breach of contract.

If you need additional information and consultations with regard to debt restructuring, please contact us by e-mail at [email protected] and by telephone at +359 882 805 057.