Authors' results highlight weak macro-economic conditions, lax bank supervision and individual bank weakness as the key factors. 

 

Forbearance describes the renegotiation of a loan's contract in case a borrower fails or is likely to fail to fulfil her obligations. Forbearance has the advantage of allowing a troubled borrower to recover from temporary, liquidity-related difficulties and at the same time it enables the lender to avoid selling collateral at a depressed price, maintaining long term client relationships. However, if a borrower faces solvency-related difficulties, forbearance might lead the lender to misallocate its resources, inefficiently shifting funds that could have been granted to new profitable loans towards bad borrowers.

 

As banks have superior information regarding the liquidity and solvency of their clients, they are well placed to decide when to forbear a loan, when to declare that a loan is non-performing and how much to set aside for the related losses.

 

However, in given circumstances, banks might have an incentive to forbear a loan even when ex ante a borrower faces solvency-related issues. Forbearance effectively enables banks to defer their impairment-related losses, thereby distorting perceptions concerning their own solvency and profitability. Remuneration frameworks, which are linked to banks' profitability, may further amplify this problem.

 

If banks consistently forbear loans when they should not, this might increase systemic risk.

Furthermore this behaviour might hamper economic growth. The lack of empirical studies about forbearance in Europe is likely due to the lack of reliable data on forbearance.

 

The European Central Bank’s (ECB) comprehensive assessment contributed to highlighting possible pockets of forbearance. In particular, the AQR adjustment to non-performing loans provides a measure of forbearance and the resulting adjustment to provisions reflects under-provisioning, thus allowing an investigation of the factors that contribute to forbearance.

 

Regression analysis using these two measures as endogenous variables provides an insight into the main drivers of forbearance and underprovisioning. The explanatory variables can be grouped as macroeconomic variables, indicators for the quality of banking supervision, measures of collateral valuation, measures of bank profitability, balance sheet-based measures of bank weakness and market-based measures of bank weakness. Using this categorisation, the variables are aligned with commonly suspected drivers of underprovisioning and forbearance.

 

The findings here can provide guidance on where to expect pockets of forbearance based on publicly available information. 

 

Press working paper