“We’re from the regulator and we’re here to help”: bank regulatory responses to the COVID-19 crisis

This time it is different!  Banks and alternative credit providers were seen as the main problem during the Financial Crisis. In 2020 governments and regulators need banks and non-bank lenders (credit providers) to be part of the solution. In particular, governments and regulators need credit providers to ease current economic strains by providing payment holidays when needed and to help sustain economies by channeling credit to consumers and SMEs. 

The Banking Payments Federation Ireland issued a press release on 13 April 2020 indicating that five leading Irish banks and six other credit providers or servicing firms have offered loan payment moratoria to business and retail customers affected by the COVID-19 pandemic. At the time of writing, approximately 45,000 mortgage payment breaks have been, or are being, processed.

From an Irish perspective, it seems clear that the credit providers themselves want to assist and play their part. There are, however, some significant restrictions within the current European and domestic regulatory framework which may, unless addressed, hinder credit providers' ability to do what they are being asked to do. This, however, has been recognised both by the Central Bank of Ireland (CBI) and international regulators who are trying to help.

We have summarised below some of the steps which regulators have taken to give additional flexibility to credit providers when considering how best to implement COVID-19 pandemic response measures.

Capital relief

The CBI announced the release of the countercyclical capital buffer, which had been set at 1% of banks' risk weighted assets since July 2019. The reduction of the buffer to 0% has the effect of allowing banks to release capital held to meet the buffer requirement to provide credit to households and businesses during the current stressed economic conditions.

The European Central Bank (ECB) separately announced that banks which it supervises are allowed to operate temporarily below levels of capital required to meet Pillar 2 Guidance buffers, the capital conservation buffer and the liquidity coverage ratio. The ECB also reminded banks that they can use their capital conservation buffer in any stressed times in line with the standards in the Basel Committee on Banking Standards' 31 October 2019 newsletter. The measures, which complement national regulators' reduction of their countercyclical buffers, means that banks will have more room to absorb losses on existing loans.

Regulators have made clear that the purpose of the measures is to support the economy generally rather than to fund dividend distributions or executive remuneration.

Loan classification

Forbearance or other indicators that loans may not be repaid as anticipated could, under existing regulatory methodologies, require banks to classify the relevant loans as non-performing loans (NPLs). Under existing regulatory methodologies, this has the knock on effect of banks having to set aside more regulatory capital and undertaking additional NPL management and reporting. 

A significant addition of NPLs onto Irish banks' balance sheets at this stage puts at risk the work done by them and broader society since the financial crisis in managing down NPLs. Regulators have sought to provide a working solution to banks which balances supervisory oversight and proper risk management of the affected exposures with the need for continued capital flow at this time.

The ECB and the European Banking Authority (EBA) have offered some supervisory flexibility to loans which have been impacted by either voluntary 'private moratoria' of the type introduced in Ireland or 'public moratoria' introduced in some other European countries. The EBA clarified that actions taken by banks in respect of loans in applying private moratoria did not automatically trigger their re-classification as NPLs or, separately, being impaired for IFRS9 purposes. 

Regulators' statements make clear that banks should continue to assess a borrower's unlikeliness to pay on a case-by-case basis. They can make this assessment taking into account the modified schedule of payments agreed through implementation of moratoria. Where a loan is renegotiated or restructured solely as a result of a COVID-19 moratorium, the guidance indicates that there is no need to automatically classify the exposure as defaulted and the restructuring as being distressed. Regulators have also indicated that only material amounts past-due need to be classified as defaulted, although this does raise questions as to the materiality threshold that should be applied. The focus on case-by-case assessments still require banks to actually make an assessment and implicitly re-classify the loan where it becomes clear that despite a moratorium the borrower is likely to have difficulties repaying. Although, the effects of the current crisis are still to be determined, it would be reasonable to expect that banks will face an increase in NPLs and provisioning for impaired loans. 

Because of the importance of NPL-related issues in the Irish financial services sector it is worth drawing out the following conclusions:

• where a loan has been impacted solely by a COVID-19 payment moratorium, regulators have provided some flexibility for banks to avoid having to classify such loans as NPLs
• the regulatory flexibility does not  remove the need for banks to consider where there may be resulting or separate (non-COVID-19) payment challenges which could result in long term financial issues for borrowers under loans when classifying and reporting on them
• banks should avoid procyclical assumptions when modelling under IFRS9 and avail of the transitional IFRS arrangements envisaged by Article 473a of the Capital Requirements Regulation
• banks and other credit providers should continue to consider from a capital and liquidity perspective the medium and long term impact of loan classifications in respect of loans on their own balance sheet but also in respect of ACS issuers which are part of their group or off-balance sheet entities which are consolidated onto their balance sheets

Supervisory requirements

Regulators have also given more supervisory breathing space to institutions. The EBA has called on domestic regulators to offer leeway on reporting dates, suggesting one-month flexibility for reports due between March and the end of May 2020. The EBA also called for flexibility in assessing deadlines for Pillar 3 disclosures. The Quantitative Impact Study based on June 2020 data has been cancelled. The EU-wide stress test has been postponed to allow banks to prioritise operational continuity. The EBA has asked national regulators to postpone non-essential supervisory activities and to be flexible with on-site inspections and deadlines for reporting. In addition, the EBA extended the deadlines for ongoing public consultations for two months, postponed public hearings and extended the date for funding plans data. Following on from this the CBI has applied regulatory flexibility in relation to deadlines for remedial actions and the verification of compliance with qualitative SREP measures. Extensions to a number of reporting deadlines have also been granted.

The ECB has also indicated that it will be flexible when assessing pre-existing NPL reduction targets, given the current market conditions. The ECB is relaxing the supervisory burden on banks given the economic distress and impairment of ordinary work practices by postponing deadlines on remediation work and investigations and the issuance of decisions.  

We expect that there will be more regulatory guidance to come as credit providers work through the practical issues that arise from implementing the flexibility given by regulators and as the effects of the current crisis become clearer.   

A&L Goodbody lawyers are helping clients to respond to the profound range of legal issues now impacting their business. Our website is updated on an ongoing basis and hosts a hub of legal issues arising from COVID-19 across all of our practice areas, which are free to access. For further information on this article please contact Peter Walker or Adrian Burke, Finance partners, Patrick Brandt, Kevin Allen or Dario Dagostino, Financial Regulation partners, Sinead Prunty knowledge lawyer or your usual A&L Goodbody Finance contact.

Date publichsed: 23 April 2020