Banking News Update – May
  • Thursday, 4 June 2020

Banking News Update – May

Unprecedented challenges for EU banks

On 25 May 2020, the European Banking Authority (EBA) published a preliminary assessment of the impact of Covid-19 on the European Union banking sector. The crisis is expected to affect asset quality and therefore the profitability of banks going forward. Nonetheless, the capital accumulated by banks above their overall capital requirements in recent years, along with the capital relief provided by regulators, amounts on average to 5 percentage points. The main takeaways from the assessment are as follows:

  • Banks have entered the Covid-19 crisis more capitalized and with better liquidity compared to previous crises (including the financial crisis of 2008-2009). The Common Equity Tier 1 (CET1) ratio rose from 9% in 2009 to nearly 15% in Q4 2019.
  • The Covid-19 crisis will have a negative impact on asset quality. As the crisis develops, banks are likely to face growing non-performing loan (NPL) volumes.
  • Banks have been using their liquidity buffers and are expected to continue using them in the coming months.
  • Banks’ operational resilience is under pressure. The handling of large volumes of applications for debt moratoria and guaranteed loans, and the insufficient preparation of some offshore units to work remotely, added some pressure on their operational capacities.

 

Covid-19 countermeasures for banks

In response to the outbreak of the Covid-19 pandemic, national and international regulators have been implementing a host of measures that are designed to offer banks leeway to support their clients and the economy as a whole. Some of the most recent and relevant initiatives include a delay of the implementation timelines for the outstanding Basel III standards and collateral measures to mitigate the tightening of financial conditions across the euro area.

Delay of Basel III implementation timelines

The Group of Central Bank Governors and Heads of Supervision (GHOS), the Basel Committee’s oversight body, agreed on 27 March 2020 to delay the implementation timelines for the outstanding Basel III standards. The implementation of the following standards and frameworks have all been deferred by one year to 1 January 2023:

  • The Basel III standards finalized in December 2017
  • The revised market risk framework finalized in January 2019
  • The revised Pillar 3 disclosure requirements finalized in December 2018

The transitional arrangements for the aggregate output floor have also been deferred by one year to 1 January 2028.

Collateral measures to mitigate the tightening of financial conditions

On 7 April 2020, the European Central Bank (ECB) adopted an unprecedented set of collateral measures to mitigate the tightening of financial conditions across the euro area. The temporary easing of collateral requirements should encourage lending during the Covid-19 crisis. According to the ECB: “The measures collectively support the provision of bank lending especially by easing the conditions at which credit claims are accepted as collateral.”

The ECB also adopted a general reduction of collateral valuation haircuts. Furthermore, and perhaps the most eye-catching measure, a waiver is installed to accept Greek sovereign debt instruments as collateral. The last time Greek bonds were accepted as collateral at the ECB was in mid-2018 when the country exited its last bailout program.

On 16 April 2020, the ECB announced a temporary reduction in capital requirements for market risk via the qualitative market risk multiplier. This multiplier is set by supervisors and used to compensate for the possible underestimation by banks of their capital requirements for market risk. By temporarily lowering the multiplier, the ECB aims to maintain the banks’ ability to provide market liquidity and to continue market-making activities.

EBA guidance

The European Banking Authority (EBA) provided further guidance on 22 April 2020 on a number of topics:

  • An amendment of the standards on prudent valuation (by the introduction of a 66% aggregation factor) to be applied until 31 December 2020 under the so-called core approach.
  • A delay in the reporting for the first FRTB-SA figures to September 2021.
  • Highlighting the flexibility in the prudential requirements available to competent authorities for banks using internal VaR models.
  • Acknowledgment of the need for a pragmatic approach to SREP assessments in 2020, focusing on the most material risks and vulnerabilities driven by the crisis.
  • To focus (in the context of recovery planning) on understanding which recovery options are necessary and available under the current stressed conditions.
  • Further clarity on the prudential application of the definition of default and forbearance as well as how the EBA Guidelines on legislative and non-legislative moratoria on loan repayments apply to securitizations.

Basel Committee on Banking Supervision measures

The Basel Committee on Banking Supervision (BCBS), introduced a series of measures to clarify how banks should consider various public and private debt relief programs in their Expected Credit Loss (ECL) estimates and in their calculation of regulatory capital. These measures are intended to incentivize banks to continue supporting the real economy, while reducing pressure on banks’ ECL provisions, earnings and regulatory capital. Please find the full statement here. We also refer to the article covering the coronavirus impact on IFRS 9 standards that was published on the Zanders website.

European Commission support package

The European Commission (EC) proposed a package on 28 April 2020 to support banks:

  • Part of this package, which is subject to approval from EU states and the European Parliament, is a temporary easing of accounting rules. Delays to repayments should not automatically lead to a harsher accounting treatment of the respective loans. As the Covid-19 crisis will have a negative impact on asset quality, these remediating actions are directed towards avoiding a sharp increase in the banks’ ECL-provisions.
  • Next to the ECL-measures, the most noteworthy other measure is an adjusted calculation of the leverage ratio. Banks will need to hold less capital for funds they hold at central banks. Officials indicated that the package should support EUR 450 billion in additional lending
  • The full package as proposed by the EC is described here.

 

Webinar: Covid-19 impact on behavioral deposit modeling

On 14 May 2020, we hosted a webinar on the impact of Covid-19 on behavioral deposit modeling in the banking industry. Around 50 ALM, risk and treasury officers from 18 distinct banks in the Netherlands, Switzerland and Denmark attended the webinar.

A poll found around 80% of the respondents have experienced the impact of Covid-19 on deposit behavior, with the impact dependent on the banks’ customer base. For over 50% of respondents, this is a trigger to re-assess their current behavioral models and focus on the evaluation of underlying key assumptions and scenario analysis development.

Because failure to apply proper behavioral modeling assumptions could result in the misreporting of Interest Rate Risk in the Banking Book (IRRBB), inaccurate hedges and increased liquidity risk, Zanders presented a number of focus points for ALM and risk managers regarding behavioral deposit modeling in crisis times.

Were you unable to attend this webinar? Or would you like to have a second look at the content? Please view the recording of this webinar, the slide deck or read more on non-maturing deposit modeling.

 

More pressure on IBOR transition timelines

On 17 April 2020, LCH issued a press release stating it will delay the transition to €STR discounting by 5 weeks, to 27 July 2020.

The decision followed an extensive dialogue with the industry in which it became clear that the switch towards working from home due to Covid-19 has taken significant time. A majority of the RFR Working Group agreed during a teleconference to postpone the deadline to allow market participants to prepare themselves while minimizing operational risk.

On 29 April 2020, the Financial Conduct Authority (FCA) reiterated that market participants cannot rely on LIBOR being published after 2021. In the same statement the FCA acknowledges that, due to Covid-19 developments, a move away from issuing LIBOR referencing products by Q3 2020 is unfeasible. As a result, the FCA now applies as a guideline that all new issuance of sterling LIBOR-referencing loan products that expire after the end of 2021 should cease by the end of Q1 2021.

 

ECB guide on climate-related and environmental risks

Since climate-related and environmental risks influence existing risk categories (such as market risk and credit risk) and can seriously impact the economy and banks, the ECB wants banks to account for these risks (and see also here).

On 20 May 2020, the ECB published a guide for consultation explaining how banks are expected to safely and prudently manage these risks and how to transparently disclose them. The aim of the guide is to raise industry awareness of climate-related and environmental risks and to enhance their management.

Banks are called to assess whether their current efforts are prudent and in line with expectations and, if necessary, to adjust them. In particular, the ECB encourages lenders to disclose more information about their climate-change risk exposures and to explicitly include such exposures in their risk frameworks. In addition, management responsibilities to cope with climate-related risks must be assigned.

Lenders are also called to take greater account of climate-related risks in the projects they choose to finance. Failing to do so could lead to reputational risks due to the increased market sensitivity towards climate-related and environmental issues. The consultation period runs until 25 September 2020. Starting next year, the ECB will ask banks to explain any deviations from the new guidelines.

On 1 April 2020, the Dutch Central Bank (DNB) published a document on good practices regarding climate-related risk management observed in the Dutch banking sector. The aim of the document is to provide non-binding guidance on how banks can cope with climate-related risks and to make banks more resilient to the financial risks resulting from climate change.

The good practices are divided into three categories: governance, disclosures and risk management. The latter category differentiates between good practices for identification, assessment, mitigation and monitoring of the climate-related risks.

 

Final guidelines on credit risk mitigation and IRB approach

On 6 May 2020, the EBA published its final guidelines on credit risk mitigation (CRM) in the context of the advanced internal ratings-based (A-IRB) approach.

These guidelines, which are part of the EBA’s regulatory review of the IRB approach, aim to eliminate the remaining significant differences in approaches in the area of CRM. The differences are due to either different supervisory practices or bank-specific choices.

The EBA and the industry have flagged that the complexity of the current provisions under the Capital Requirements Regulation (CRR) on the CRM framework raises a significant number of implementation issues. Previously, the EBA had published the EBA Report on the CRM framework, mainly focusing on the standardized approach (SA) and the foundation-IRB approach (F-IRB).

The guidelines are also complementary with EBA Guidelines on the PD estimation, LGD estimation and the treatment of defaulted exposures. The implementation deadline of all of these guidelines, on CRM, PD, LGD and defaulted exposures, is 1 January 2022.

 

Contact us

Please get in touch with Jaap Karelse or Sjoerd Blijlevens if you want to get more information on financial market developments and the Covid-19 impact on the financial sector.