27 May 2021
- The cost of risk (CoR) of EU banks rose from 0.45% in December 2019 to 0.82% in June 2020 while the CoR of US banks jumped from 0.54% to 2.16% in the same period.
- Differences in the macroeconomic impact of the pandemic across the two regions, in the loan portfolio composition of US and EU banks and in accounting frameworks for the recognition of expected credit losses (ECL) help explain the different evolution of the CoR.
The European Banking Authority (EBA) published today a thematic note comparing provisioning practices in the US and the EU during the peak of the COVID-19 pandemic. The note looks into the differences in the macroeconomic impact of the pandemic, in banks’ loan portfolios, and in accounting rules that might explain why the CoR of US banks was much higher compared to their EU peers in the first half of 2020 and fell at a faster pace afterwards.
Looking at data over the past 13 years, following an economic shock, loan loss provisions of EU banks tend to be less volatile than those of US banks. In a similar vein, in the first two quarters of 2020, the CoR of US banks was much higher compared to EU banks. However, in the second half of 2020, the CoR of US banks fell more rapidly compared to their EU peers.
The impact of the pandemic on macroeconomic variables helps explain some of the differences in CoR. The US suffered a higher increase in unemployment in the early stages of the pandemic that might contribute to the sharper rise in CoR compared to EU banks. Similarly, a faster economic recovery in the US might explain the faster fall in the second half of 2020.
A preliminary analysis also reveals a riskier loan portfolio composition of US banks. The share of the portfolios potentially more affected by social distancing and containment measures such as commercial real estate or consumer credit over total loans granted is higher in the US. This could be a further explanation for the higher CoR at the onset of the pandemic.
Different accounting rules can also lead to differences in CoR. Under CECL, banks recognise lifetime ECL for all financial assets whereas under IFRS 9 the 12-month ECL is recognised for Stage 1 loans. At the onset of a crisis, the IFRS 9 impairment model presumably resulted in a rise in CoR because of loan migrations from Stage 1 to Stages 2 or 3, for which lifetime ECL were recognised. However, this effect seems to be less material than the impact of applying the CECL approach to all financial assets.