The COVID-19 pandemic has been hard on everybody—including financial institutions. Widespread financial instability resulted in job losses and furloughs, leaving millions of people unable to pay their bills. As a result, governments stepped in and introduced much-needed loan moratoria or debt relief orders (DROs), i.e. a delay in the payment of debts or obligations:
- A wide variety of moratoria has been introduced across the world: eviction moratorium, utility bill deferments, moratoria on loan repayments, and more. These measures have given people a sense of financial security, if only for the time being.
- But loan moratoria cannot continue forever. Indeed, according to the European Central Bank (ECB): “loans emerging from [European Banking Authority] (EBA) moratoria and the other COVID-19 forbearance measures have so far performed slightly worse than the overall loan book, while signs of weakening credit quality (Stage 2) are apparent among outstanding measures.”
- This is bad news for financial institutions. In Spain, for example, 87% of moratoriums have already expired—and the country’s banks are currently €8BN in default.
This blog post will dive into what moratoria are, what types of debt they cover, the problems that emerge once they expire, and why financial institutions need to act fast.
What is a moratorium—and how does it work during a pandemic?
Essentially, a moratorium refers to “a legally authorized period of delay in the performance of a legal obligation or the payment of a debt”. Imagine you owe €2,000 per month in rent payments but have just lost your job. In the event of an eviction moratorium, it would be illegal to remove you from your rented accommodation—even if you couldn’t pay your rent. Or perhaps you have a €10,000 loan and usually make €500 monthly payments towards paying it back. If a loan moratorium was introduced, you could pause these payments entirely until the moratorium has expired.Essentially, a moratorium refers to “a legally authorized period of delay in the performance of a legal obligation or the payment of a debt”. Imagine you owe €2,000 per month in rent payments but have just lost your job. In the event of an eviction moratorium, it would be illegal to remove you from your rented accommodation—even if you couldn’t pay your rent. Or perhaps you have a €10,000 loan and usually make €500 monthly payments towards paying it back. If a loan moratorium was introduced, you could pause these payments entirely until the moratorium has expired.
As you can imagine, moratoria are especially welcome during periods of significant economic hardship (such as a pandemic or a recession). They play a pivotal role in supporting people through tough times and keeping general societal disruption to a minimum. For example, an eviction moratorium means that people don’t have to leave their homes and it also reduces other problems like homelessness or the chance that people will unnecessarily spread COVID-19 while moving out.
What types of debt are eligible for moratoria?
There are 3 main types of debt that are usually eligible for moratoria:
1. Rent and mortgage arrears
If homeowners and renters fall into arrears and are unable to meet their scheduled repayments (such as mortgage or rental payments), then they usually have to evacuate the premises.
With rental and mortgage moratorium, they can continue to live in their home until the moratorium has expired. However, if they want to continue living in their home beyond the expiration date of the moratorium, they need to pay back or promise to pay back what they owe from the time period of moratoria.
2. Consumer credit agreements (e.g. loans and credit cards)
In consumer credit, interest is the biggest issue during times of crisis. Missing payments or not paying the full minimum payment amount will increase your interest drastically. So with moratoria, eligible borrowers don’t have to pay interest on top of their interest for the given time period. But given that this is only for borrowers who are not overdue in their payments.
However, with consumer credit moratoria, businesses and consumers don’t have to make their scheduled repayments as usual. This policy provides borrowers with much-needed breathing space during uncertain economic times.
3. Utility and fuel arrears
Rent/mortgage and consumer credit moratoria are great, but they’re not the only things that people have to pay for. Take utilities, for example. Paying your utility providers can be a matter of life-and-death. If you lack heating during winter, you’re going to struggle. Unfortunately, it has been reported that over 80 million Americans are currently struggling to pay their bills as a result of the COVID-19 recession.
This is where a moratorium on utility shut-offs comes in, allowing people to still access much-needed resources even if they’re unable to pay for them right away.
What happens when moratoria expire?
Moratoria might be a life-saver for consumers during tough times, but it will not last forever. Eventually, customers are going to have to pay what they owe—or suffer the consequences. Banks and businesses cannot wait indefinitely to be paid. However, they need to have an effective strategy in place (backed up by robust policies) to ensure this process is as seamless as possible.
For starters, many people will be at risk of eviction as they’re unable to pay what they owe. This is a particularly worrying problem in both the US and Europe. And people who rely heavily on utility moratoria are also expected to be badly affected once they come to an end.
The breathing space provided by moratoria will quickly disappear once they expire. Repayments might have been paused temporarily—but during this time, consumers’ debts have been mounting. If various moratoria all expire within a short space of time, people will suddenly be faced with a huge stack of bills that many of them will simply be unable to pay.
But this isn’t all. When consumers are unable to pay what they owe, banks see a sharp rise in the number of non-performing exposures (NPEs) and non-performing loans (NPLs). This causes its own knock-on effect. Financial institutions have to spend more time, money, and energy trying to collect bad debts—many of which will never materialise. They might even have to sell their bad loan portfolio for a fraction of what it’s really worth just to generate at least some value from it.
COVID-19 has already wreaked economic havoc—but this is only the tip of the iceberg. When moratoria expire, both consumers and financial organisations will have to come to terms with reality.
How financial institutions can prepare for the expiration of loan moratoria
However, banks and other financial institutions must use this time to prepare for NPLs’ and NPEs’ impending arrivals. They need to ensure, first and foremost, that they’re operating with the right systems in place to decrease the likelihood that debts become non-performing. They require collections management software that offers:
- Self-service functionality: Let consumers take control over their own debt repayments, providing them with a sense of agency and increasing the chance that they will engage with the dunning process.
- Case management abilities: Drill down into the specifics of each individual past-due customer: their outstanding debts, active claims, financial history, communication preferences, and so on. Treat every customer as an individual, tailoring your approach according to their specific context and requirements.
- Business intelligence dashboards: Manage your data more effectively and keep an eye on your recovery metrics at all times. Identify what works and what doesn’t, honing in on the ideal strategy for every segment and every individual.
- Financial assessment and portfolio management: Assess, analyse, and understand your debt portfolio in depth. Classify your debts in terms of risk and appropriately value your portfolio in the event of selling off your NPLs.
Ride the impending wave of NPLs
Moratoria have had a profound impact throughout the pandemic, safeguarding people from the consequences of being unable to meet their scheduled repayments. But loan moratoria cannot stay on ice forever. As banks and utility providers begin to chase their outstanding debts, NPLs will rise sharply.
This is indeed a challenge, but it’s not unsurmountable. By leveraging an all-in-one collections and recovery platform, financial institutions can prevent debts from becoming non-performing—and better value those that are NPLs. In other words, they can make the best out of a bad situation.
To learn more about receeve’s future-proofed collections management system, book a demo today.