Loan repayment holidays: distinguishing between illiquid and insolvent borrowers

Property investors have been facing rent shortfalls and renegotiation of leases as a result of the pandemic.  Many other investors have seen their usual income streams squeezed too. 

Some measures introduced to assist those affected have been the suspension of debt obligations owed to banks and other financial institutions - aka debt ‘repayment holidays’.  In the UK, payment holidays are being offered for up to three months on loans under guidelines published by the Financial Conduct Authority. 

There is a growing fear that borrowers who requested capital repayment holidays may face higher interest rates or even be denied loans in the future.  However, there should not be an automatic assumption that borrowers who have been granted payment holidays have experienced credit deterioration.  

Banks and other lending institutions should differentiate between borrowers whose cash flow difficulties are considered temporary (i.e. they are solvent but temporarily illiquid) and those borrowers who may already have been struggling to meet their financial obligations before the onset of Covid-19.  

The Financial Stability Institute (part of the Bank of International Settlements) has recently published some guidance on how borrowers should be classified in the context of debt repayment holidays.