Banks and Regulation
The road ahead in the United Kingdom and Europe - Covid-19 action plans for the coming weeks and months.
On the 20th March 2020, the Basel Committee held a conference and shared a press release on the impact of the rapid spread of the coronavirus Covid-19 on the global banking system[1]. The Committee stated its full support for the regulators in their efforts to encourage banks to use their capital and liquidity buffers from the Basel III framework, including their stock of high-quality liquid assets (HQLA) as resources to sustain the economy. Many supervisors, including the Federal Reserve in the US, have similarly released statements encouraging banks to use such tools as a response to the current crisis[2].
A press release issued by the European Central Bank the same day outlined further flexibility for EU banks in their response to Covid-19[3]. The capital and operational relief measures announced by the ECB on March 12th 2020 have been activated. According to these, banks can operate below the Pillar 2 Guidance (P2G), the capital conservation buffer (CCB) and the liquidity coverage ratio (LCR). Instruments that do not qualify as CET1 capital can be partially used to meet the Pillar 2 Requirements (P2R), and this will bring forward relief to the amount of €120 billion, which could be used to absorb losses, or potentially finance up to €1.8 trillion of lending.
Loans to debtors distressed by the Covid-19 outbreak will also qualify for more favourable prudential treatment. Supervisory flexibility will be applied to:
- non-performing loans (NPLs),
- classification of debtors as “unlikely to pay”, and
- loans under Covid-19 related public moratoriums.
There will be preferential prudential treatment for loss provisioning of loans which become non-performing and are under public guarantee. Considering the unusual current market conditions, supervisors will offer full flexibility when NPL reduction strategies are being discussed with the banks. Additionally, the ECB, advises banks to avoid excessive procyclical effects when applying the IFRS 9 international accounting standards.
The Bank of England (BoE) and Prudential Regulation Authority (PRA) announced on 20.03.2020 several supervisory and prudential policy measures to address Covid-19 challenges[4]. The following steps are included in their press release:
- Cancellation of the Bank’s 2020 annual stress test – the annual cyclical scenario (ACS) – to allow banks to focus on the needs of UK households and businesses;
- Amendment to the biennial exploratory scenario (BES) timetable – the liquidity exercise has been paused until further notice, and the responses to the BoE’s Climate Risk paper will be considered in summer 2020;
- Bank statement on IFRS 9 and Covid-19 – currently there is not enough forward-looking information used to incorporate the impact of coronavirus on borrowers into the expected credit loss (ECL), hence the PRA finds the preparation of reliable and detailed forecasts very challenging at present. Further guidance on this will be provided by the BoE this week (23.03.2020 - 27.03.2020);
- Postponement of the joint BoE / Financial Conduct Authority (FCA) survey into open-ended funds – it has been delayed until further notice with a delay on subsequent FCA consultation that should follow;
- Supervisory programmes for individual firms and FMIs – postponement of non-critical data requests, on-site visits and deadlines;
- Senior Manager Function (SMF) application – the process is to be reviewed keeping in mind current events;
- Operational Resilience Policy Development – ongoing BoE / PRA consultations “Building Operational Resilience: impact tolerances for important business services” and “Outsourcing and third-party risk management” are extended to 1 October 2020;
- Internal Ratings Based (IRB) models – implementation of the proposals published in Consultation Paper (CP) 21/19, and related to the Definition of Default, Probability of Default, and Loss Given Default estimation will be delayed by one year to 1 January 2022;
- Financial Services Regulatory Initiative Forum (RIF) – first meeting (BoE, PRA, FCA) will take place in April 2020;
- Basel III – the government announced, that it will introduce legislation enabling Basel III.
The action plans for the EU and the UK outlined above are not set in stone. Keeping in mind the exponential rise in the number of people infected by the virus, as well as the uncertainty ahead, changes to existing measures and the announcement of new measures are to be expected every day. What is clear though is the commitment of central banks and regulatory authorities to ensure that all segments of the economy can benefit from a strong and well-supported banking sector.
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[1] Basel Committee coordinates policy and supervisory response to Covid-19
[2] Federal Reserve Q&As on Statement Regarding the Use of Capital and Liquidity Buffers
[3] ECB Banking Supervision provides further flexibility to banks in reaction to coronavirus
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