Interest rate cuts are aimed at encouraging firms and households to spend by making borrowing more attractive, and saving less so. But when rates are negative, their transmission to the real economy breaks down, as depositors can always choose to hold their funds in cash. The results are squeezed net interest incomes for banks and a reduced willingness to lend. Central banks worry that the stimulating effect of an interest-rate cut is offset by the strain placed on banks.
Initially, the European Central Bank (ECB) tried to resolve this using the long-term repo operations (LTROs): the more a bank lends to the private sector, the lower the TLTRO rate. Until March, the rate was tied to the ECB’s benchmark interest rates. But the link has since been severed: banks can now access funds at a much lower interest rate of -1%. Hence, banks can now make a profitable spread when they use the proceeds to make new loans. Meanwhile deposit rates remain closer to zero, preventing savers from running to the door. The FD points out, however, that the additional liquidity also comes at a cost.
In the second half of 2019, the ECB Banking Supervision conducted an assessment of Euro Area banks’ preparedness for the benchmark rate reforms. The assessment found that banks had focused more on the transition from EONIA to the €STR than on addressing the risks related to a possible future discontinuation of EURIBOR. Another key finding was that, while banks were aware of the potential risks associated with the reforms, they were generally behind schedule in developing and implementing mitigation actions.
In the light of the above, the ECB published a report intended to assist banks by setting out good practices for banks’ governance structure, risk identification approaches, action plans and documentation in relation to the benchmark rate transition. The good practices cover legal and operational challenges, including contract repapering, fall-back provisions and communication strategy.
With banks performing a key role in financing households and businesses, it is crucial that they are sufficiently resilient to play their part – both in good times and in bad. Pivotal to this is the internal capital adequacy assessment process (ICAAP), which helps banks to make well-founded business and risk management decisions and maintain an adequate capital position. The ECB carried out an analysis of banks’ ICAAP practices, looking at where the sampled banks stood in relation to its expectations. The findings from this analysis have now been published in the ECB Report on banks’ ICAAP practices. The ECB acknowledges that banks have made considerable effort and significantly improved their ICAAPs in recent years.
There is, however, more to be done. While the analysis revealed several relatively underdeveloped ICAAP areas, which all deserve attention, there are three main areas for further improvement: data quality, the economic internal ICAAP perspective, and stress testing.
Please contact Jaap Karelse for more information on ICAAP.
On 3 August 2020, the European Banking Authority (EBA) published its final draft Implementing Technical Standards (ITS) on disclosure and reporting on the global systemically important institutions (G-SIIs) minimum requirements for own funds and eligible liabilities (MREL) and for the total loss absorbency capacity (TLAC).
These standards cover information on the total loss absorbency capacity framework that G-SIIs have to comply with, and on the minimum requirement for own funds and eligible liabilities, that may apply to any institution, in an integrated manner.
This is the first time that the EBA has developed disclosure and reporting requirements in this area, thus expanding the scope of the existing Pillar 3 and supervisory reporting frameworks in the EU.
Please contact Gijs Immerman for more information on EBA technical standards on disclosure and reporting on MREL and TLAC.
The EBA published their next consultation of the EBA roadmap for the new market and counterparty credit risk approaches. The consultation concerns guidelines on criteria for the use of data inputs in the expected shortfall risk measure under the Internal Model Approach (IMA). Institutions using the IMA to compute own funds requirements for market risk are required to compute the expected shortfall (ES) risk measure for those risk factors for which a sufficient amount of verifiable prices is available (modellable risk factors).
The guidelines clarify the conditions that should be met by the data related to modellable risk factors: the data used to compute the ES risk measure should be (i) accurate, (ii) appropriate, (iii) frequently updated and (iv) complete and overall consistent in its use in the ES risk measure. The consultation runs until 12 November 2020.