Banking News Update – October
  • Tuesday, 20 October 2020

Banking News Update – October

Market developments amid the Covid-19 pandemic

The European Central Bank (ECB) provided relief worth EUR 73 billion from a key capital requirement in order to help them keep credit flowing amid the Covid-19 pandemic. Banks that are supervised by the ECB will be allowed to exclude claims to central banks, including deposits, from the calculation of their leverage ratio. The leverage ratio, which requires banks to hold capital worth 3% of their total exposure, will only become binding in July 2021 but banks are already required to disclose it. This leeway is provided until 27 June 2021.

The Dutch Central Bank (DNB) followed this initiative from the ECB and provided this relief also to banks under its jurisdiction. The initiative is meant to support the monetary policy of the ECB. Furthermore, DNB has announced that it will maintain the measures as installed in March to enhance the lending capacity of banks. In addition, the floor on the risk weight of mortgages and the countercyclical buffer will not be introduced before 2021. Another initiative from the ECB to incentivize lending by banks, is the instalment of targeted loans (TLTROs). This will give banks access to long-term funding for an interest rate as low as minus 1%. This effectively means that the ECB pays banks to borrow money as long as they lend the cash onto companies and households.

The European Banking Authority (EBA) phases out its guidelines on legislative and non-legislative loan repayments moratoria. These guidelines, which were published in the early phases of the Covid-19 pandemic, have provided the necessary flexibility as well as certainty on the regulatory framework, in light of the significant number of actions taken by banks to support their customers as exceptional lock-down measures were put in place. According to the ECB, Euro zone banks need to prepare for a rapid deterioration in their balance sheets and take decisive steps to restore profitability.

Climate risk stress testing and capital requirements

On 10 September 2020, Fitch Ratings published a report on climate change stress tests and their expectations on capital requirements. They conclude that EU and UK supervisors are the most advanced in efforts to quantify climate risks of banks and note that UK and French regulators are among the first to require stress tests for climate change. While these stress tests will not formally test banks’ capital adequacy nor will be used to set capital requirements, Fitch expects that climate change stress tests will eventually feed into prudential capital requirements for European banks. According to Fitch, the outcomes of stress tests will likely influence how much capital banks need to set aside for Pillar 2 risks: the ECB is already guiding large banks to incorporate climate risks into their Pillar 2 capital adequacy assessments. While the EBA is also considering including climate change sensitivities in the 2021 EU-wide stress tests, the US shows no sign of introducing climate risk stress tests for banks yet.

In addition, the UN Environment Programme Finance Initiative (UNEP FI) has published a report that provides financial institutions with a blueprint for evaluating physical risks and opportunities. The report assesses best practices for five critical topics:

  1. Extreme events data and data portals
  2. Portfolio physical risk heatmapping
  3. Tools for physical risk assessments of financial risk
  4. Physical risk correlation analysis of finance institutions portfolios
  5. Analysis of opportunities driven by physical climate risk

Updated timetable for ISDA’s IBOR Fallbacks Protocol

The International Swaps and Derivatives Association (ISDA) is on the cusp of publishing a supplement to the 2006 ISDA Definitions plus a protocol that would introduce robust fallbacks for derivatives contracts, which is an important step in mitigating the systemic risk that could arise from the cessation of key interbank offered rates (IBORs). ISDA expects that the effective date will not be before the second half of January 2021; being subject to ISDA receiving a positive business review letter from the US Department of Justice and then finalizing work with competition authorities in other jurisdictions.

From that point on, all new derivatives referencing the 2006 ISDA Definitions will automatically include the updated fallbacks. The changes will apply to legacy derivatives as well if both counterparties have adhered to the protocol, or have agreed similar bilateral amendments. Certain central counterparties (CCPs) also plan to apply the updated fallbacks to all cleared over-the-counter derivatives from the effective date.

The IBOR Fallbacks Protocol will be voluntary – firms could choose to make changes to their legacy contracts on a bilateral basis or opt to keep their outstanding trades unchanged. The ISDA board of directors expressed its support for broad adherence, however.