(Bloomberg) --

European banks are underestimating the risks they face from borrowers hit hard by the pandemic, potentially laying the ground for an increase in bad loans, according to their top regulator.

Two-thirds of the models banks use to calculate loan risk are factoring in a lower probability of default for companies in the hotel and accommodation industry than before the pandemic, said Edouard Fernandez-Bollo, a member of the European Central Bank’s supervisory board.

“Who can believe that? This is completely counter-intuitive,” he said at a conference on Friday. “The backward-looking risk metrics that the banks are using are no longer fit for purpose today because they are underrating the risk, because they are projecting in fact implicitly the continuation of the credit support given by the state and this is not the case.”

The risk models rely on data from the previous decade, meaning they have factored in the lack of defaults during the pandemic and “mechanically, without maybe real deliberation,” he said.

The ECB is pushing banks to take account of potential risks when issuing new loans in order to avoid a build up of soured debt in the future, Fernandez-Bollo said. Still, the industry “is in a good place” and has tackled the pandemic, also thanks to public support measures, he said.

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