Regulatory flexibility gives banks the tools to support the economy during the coronacrisis

24 April 2020 - With banks no longer the weak link in the financial system, they now have a key role to play in supporting the real economy to survive the coronacrisis. The significant strengthening of prudential regulation over the past decade since the 2008 financial crisis has enabled banking institutions to post solid levels of capital and liquidity, putting them in a stronger position to cope with this unprecedented shock.

THE REGULATORY FRAMEWORK CONTAINS SPECIAL MEASURES FOR TIMES OF CRISIS

In a European economy mainly financed by banks, it is essential that the effects of monetary policies adopt-ed by central banks in response to the current crisis are rapidly transmitted to businesses, households and other key players in the economic system.

The Financial Stability Board (FSB) has confirmed that the financial system is in a better position to withstand shocks as a result of the post-crisis reforms. As a result, the FSB is encouraging authorities and financial institutions to make use of the flexibility within the regulations to keep the markets open and support the financing of the real economy. [1]

Against this background, the Basel Committee observes that the Basel III framework includes capital and liquidity buffers that are designed to be used in periods of stress [2] and supports measures taken locally by its members to alleviate the impact of the coronacrisis on financial stability.

ENCOURAGEMENT TO LEND BY RELEASING CAPITAL FOR THE BANKS AND AVOIDING INTER-BANK TENSIONS

One of the main lessons of the 2008 crisis was that the banks lacked adequate safety buffers to enable them to absorb major shocks at times of stress.

For this reason, several buffers were introduced in addition to the minimum Pillar 1 regulatory requirements: the capital conservation buffer (CCoB), the countercyclical capital buffer (CCyB), and the systemic buffer (SIIB). Apart from the requirement for combined buffers, regulators have also imposed additional requirements on the banks under Pillar 2 (P2R) to cover the risks which are not covered by Pillar 1, along with Pillar 2 guidance (P2G) for coping with shocks caused by hypothetical stress.

In March 2020, the European Central Bank (ECB) took several measures intended to reduce capital requirements, thus unlocking new lending capacity estimated at €1800 bn [3] as recommended by the European Banking Authority (EBA) [4]:

  • Authorisation to operate below the P2G;
  • Use of combined buffers: in this instance, restrictions on distribution apply only within the limits of the maximum distributable amount (MDA);
  • Use of the liquid assets buffer, even if this means operating below the minimum Liquidity Coverage Ratio (LCR) of 100%, to ensure liquidity in the system and avoid spill over effects;
  • Possibility of satisfying the P2R with capital instruments that do not qualify as Common Equity Tier 1 (CET1) capital, bringing forward a measure due to come into effect in January 2021, as part of the Capital Requirements Directive (CRD) V;

ADDITIONAL SURETIES

The EBA has also moved to clarify the prudential treatment of public or private moratoriums granted by banks to their customers to address the current crisis [5]. For the identification of default, the EBA confirms that the 90 days past due criterion must be based on the new payment schedule agreed with the customer. The EBA also clarifies that moratoriums that are not customer-specific, but rather address a broad range of borrowers, will not be automatically classified as forbearance measures. However, an institution must continue to monitor any probable indication of non-payment using the EBA’s definition of prudential identification of default.

These measures should make it possible to avoid a wave of defaults directly due to the coronacrisis. Dutch banks have now announced that they are ready to grant their smaller business customers a deferral of loan repayments of up to six months. In terms of its guidance on non-performing loans (NPLs), the ECB shows flexibility: where an exposure is covered by a public guarantee or moratorium, that exposure will not automatically be characterised as probable non-payment. Additionally, the NPLs covered by a public guarantee may benefit from the exceptional treatment applicable to export loans, i.e. 0% of prudential provisioning during the first seven years.

Finally, from an accounting angle, the EBA and ECB hope that the procyclical impacts of IFRS 9 in conjunction with the crisis are mitigated to the extent allowed by the standard. Both the EBA and ECB stress that firms can make use of article 473a of the CRR to spread the capital impact of IFRS 9 over a five-year period.

POSTPONEMENT OF SIGNIFICANT 2020 DEADLINES

The EBA has announced the postponement of the 2020 stress testing exercise until 2021, in light of the vast and very real stress test that banks now face. The EBA is also encouraging the competent authorities to suspend any non-essential supervisory activities and to allow banks some leeway for the submission of some areas of supervisory reporting. For example, the ECB has announced a six-month postponement of the dead-line for remedial actions imposed following its review of internal models (TRIM), on-site inspections, and compliance with 2020 SREP decisions.

Want to know more?

Do you require more information? Please contact Kees Harteveld by email or by phone +31 (0)88 277 15 76 or Carel van Oldenbeek by email or by phone +31 (0)88 277 24 67. They will be happy to help you.

This is a translation of the original article written by David Labella , Head of Prudential Regulatory Affairs

Sources:

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