- Governments and banks have introduced payment deferral programmes to support borrowers affected by Covid-19. But deferred payments are not forgiven and must be repaid in the future, raising prospective risks to the banking system. Thus, they should be designed to balance near-term economic relief benefits with longer-term financial stability considerations.
- The Basel Committee on Banking Supervision (BCBS) and several prudential authorities have issued statements clarifying how payment deferrals should be considered in assessing credit risk under applicable accounting frameworks. These measures aim to encourage banks to continue lending, to avert an even deeper recession.
- Prudential authorities are caught "between a rock and a hard place" as they encourage banks - through various relief measures - to provide credit to solvent, but cash-strapped borrowers, while keeping in mind the longer-term implications of these measures for the health of banks and national banking systems.
- In navigating these tensions, banks and supervisors face a daunting task as borrowers that may be granted payment holidays have varying risk profiles. Distinguishing between illiquid and insolvent borrowers - amidst an uncertain outlook - should help guide banks' efforts to support viable borrowers, while preserving the integrity of their reported financial metrics.
Key takeaways from the report area as follows:
- Central banks in advanced economies reacted swiftly and forcefully to the Covid-19 pandemic, deploying the full range of crisis tools within weeks. The initial response focused primarily on easing financial stress and ensuring a smooth flow of credit to the private non-financial sector;
- The pandemic triggered complementary responses from monetary and fiscal authorities. Fiscal backstops and loan guarantees supported central bank actions. Asset purchases, designed to achieve central banks’ objectives, helped contain the costs of fiscal expansions; and
- The footprint of central banks’ measures will be sizeable. Across the five largest advanced economies, balance sheets are projected to grow on average by 15–23% of GDP before end2020 and to remain large in the near future.
Criminals are exploiting vulnerabilities opened up by the Covid-19 lockdown, increasing the risks of cyber attacks, money laundering (ML) and terrorist financing (TF).
Authorities worldwide have responded by drawing financial institutions' attention to these threats and by providing guidance on ways to improve cyber security and mitigate ML and TF risks.
Financial authorities are warning financial institutions to be particularly watchful in relation to their IT networks and non-public data; third-party risk; and cyber security incident response plans; and to focus additional effort on staff training and awareness.
Financial authorities also emphasise the need for financial institutions to be vigilant of new ML and TF risks and to continue meeting anti-money laundering (AML) and combating the financing of terrorism (CFT) requirements, while using the flexibility built into the AML/CFT risk-based framework, digital customer on-boarding and simplified due diligence processes.
In both areas, the official guidance underscores the trade-offs between expecting financial institutions to enhance or adjust their cyber resilience and AML frameworks and, on the other hand, avoiding imposing an excessive burden that could hinder financial institutions in delivering key financial services.
In response to the Covid-19 pandemic, governments have launched guarantee programmes to support bank lending to companies, especially small and medium-sized enterprises. This is essential to avoid a sharp contraction in bank credit that would exacerbate the pandemic's adverse impact.
The design of such programmes needs to strike a difficult balance between responding promptly to the pandemic and maintaining a sufficient level of prudence. Key features of a sample of programmes (eg target beneficiaries, coverage of the guarantee, loan terms, length of the programme) reflect this tension.
Incentives were created for the banks to join these programmes by exploiting flexibility in existing prudential requirements, while central banks have often provided liquidity support. Programmes are, however, subject to operational challenges and, ultimately, fiscal capacity limits.
The Bank for International Settlements (BIS) published a bulletin entitled “Buffering Covid-19 Losses – the Role of Prudential Policy”, suggesting conditions to address the shock coronavirus pandemic has had on the economy through release of prudential buffers. The bulletin is divided into three parts: 1. Assessment of how banks are and will be affected by Covid-19 confinement measures and policy responses to the pandemic; 2. design and usability of prudential buffers; and 3. relaxing buffers to support banks.
According to BIS the following are key takeaways from the bulletin:
- “By allowing banks to run down some of their buffers, policymakers are sending a strong signal about their resolve to lessen the economic fallout from the pandemic. Such prudential measures complement the main policy levers: monetary and fiscal instruments.
- To avoid a reduction in credit to the real economy, authorities need to ensure that banks have the capacity and willingness to make use of the flexibility afforded by the buffer release. Payout restrictions on banks and risk-sharing between banks and the public sector will be key.
- For banks to continue playing a positive role in the supply of funding during the recovery, they should maintain usable buffers for a long period, as losses from a severe recession will take time to materialise.”
The Bank for International Settlements published working papers entitled, “Post-crisis international financial regulatory reforms: a primer”, which reviews post-crisis regulatory reforms, specifically reviewing the bank and Central Counterparties (CCP) international regulatory reforms and how CCP international standards fit within a “unified analytical framework”. The CCP reforms were implemented in response to the Great Financial Crisis (GFC) with the purpose of improving financial stability through the implementation of improved and new standards. The BIS working paper is primarily based on a review of the unified analytical framework and premised on the belief that the key concept of the framework is “shock-absorbing capacity, which is higher when (i) there is less exposure to the losses that a shock generates and (ii) there are more resources to absorb such losses.” The working paper argues that a “conservative regulatory approach” is necessary to address issues of political pressures on the economy and technical obstacles to reform, and “[a] higher cost of balance sheet space is a healthy side effect of the backstops underpinning such an approach". BIS’ summary of this working paper can be found here.
Currently, insurers are more likely to experience losses from financial market volatility than from higher insurance claims arising from Covid-19. Few insurance supervisors have seen a need to strengthen or adjust prudential requirements to insulate insurers from current financial market uncertainties.
So far, authorities have responded mainly by taking measures to provide operational relief to insurers from regulatory and supervisory requirements so that they can continue providing insurance services. These measures will also help insurers to enhance risk monitoring of their Covid-19 financial exposures.
Some authorities have set out expectations for insurers to conserve capital through prudent exercise of dividend and variable remuneration policies. The aim is to enhance their resilience against huge uncertainties from potential Covid-19 fallout. Other capital-related measures should relieve supervisory pressures and reduce the tendency of insurers to manage their investments in a procyclical manner. These measures include: extending the supervisory intervention ladder, triggering the countercyclical lever and recalibrating capital requirements.
The far-reaching impact of Covid-19 calls for sustained vigilance by both supervisors and insurers. In the post-pandemic phase, the extraordinary measures currently warranted will need to be unwound through a carefully crafted exit strategy that preserves sound risk management practices and protects policyholders' interests.
In the wake of the Covid-19 pandemic, several prudential authorities and the Basel Committee on Banking Supervision (BCBS), introduced a series of measures to clarify how banks should consider various public and private debt relief programmes in their ECL estimates and in their calculation of regulatory capital. These measures are intended to incentivise banks to continue supporting the real economy, while reducing pressure on banks' ECL provisions, earnings and regulatory capital.
Supervisory initiatives that provide capital relief should be augmented by severe constraints on the payment of dividends, bonuses and share buybacks. These joint actions will simultaneously expand banks' lending capacity and enhance their ability to absorb losses.
Prudential authorities face difficult trade-offs as they confront the most severe economic crisis in modern times. Encouraging the use of flexibility in applicable accounting standards, while preserving market trust and transparency in the reported financial statements of banks, will be key in fostering both economic and financial stability.
- Critical/essential employees: identifying the critical functions and employees that support important business services, as well as ensuring employees' safety and that they can safely resume their duties (remotely, if necessary).
- IT infrastructure: ensuring that IT infrastructure can support a sharp increase in usage over an extended period and taking steps to safeguard information security.
- Third-party service providers: ensuring that external service providers and/or critical suppliers are taking adequate measures and are sufficiently prepared for a scenario in which there will be heavy reliance on their services.
- Cyber resilience: remaining vigilant in order to identify and protect vulnerable systems, and detect, respond and recover from cyber attacks.
- Regulatory policy responses should seek to support economic activity while preserving the financial system's soundness and ensuring transparency.
- The recommendation for banks to make full use of capital and liquidity buffers should go hand in hand with restrictions on dividends and bonuses and clarity concerning the process for rebuilding them.
- Flexibility in loan classification criteria for prudential and accounting purposes should be complemented with sufficient disclosure on the criteria banks use to assess creditworthiness.
- The publication of detailed guidance on the application of expected loss provisioning rules, combined with sensible transitional arrangements, may constitute a balanced approach to mitigating the unintended effects of the new accounting standards.
The Bank for International Settlements released a bulletin entitled, Covid-19, cash, and the future of payments, which addresses growing public concerns and questions about the possibility of transmitting viruses through cash. The Covid-19 pandemic has understandably catalyzed apprehension surrounding issues of hygiene, safety and transmission of the virus; and it logically follows that the public will have concerns about the physical use of cash. BIS’ bulletin establishes from the onset that its key takeaways are the following:
- “The Covid-19 pandemic has fanned public concerns that the coronavirus could be transmitted by cash.
- Scientific evidence suggests that the probability of transmission via banknotes is low when compared with other frequently-touched objects, such as credit card terminals or PIN pads.
- To bolster trust in cash, central banks are actively communicating, urging continued acceptance of cash and, in some instances, sterilising or quarantining banknotes. Some encourage contactless payments.
- Looking ahead, developments could speed up the shift toward digital payments. This could open a divide in access to payments instruments, which could negatively impact unbanked and older consumers. The pandemic may amplify calls to defend the role of cash – but also calls for central bank digital currencies.”
The BIS bulletin further reports the increase of media inquiries and internet searches regarding the safety of handling cash, with countries such as Australia, France, Singapore, Switzerland, Ireland, the United Kingdom, Canada, the United States, Jamaica and Kenya leading with the highest number of searches on this topic as of the publication of this bulletin on April 3, 2020. The bulletin concludes by placing emphasis on the value of central bank digital currencies (CBDCs), but with the caveat that they must be accessible to the underbanked with contact-free technical surfaces appropriate for the entire population. “The pandemic may hence put calls for CBDCs into sharper focus, highlighting the value of having access to diverse means of payments, and the need for any means of payments to be resilient against a broad range of threats.”
WOCCU will continue to follow finance and financial regulatory issues surrounding the Covid-19 pandemic as they develop.
In response to a growing demand for climate-friendly investments, the Bank for International Settlements (BIS) launched an open-ended green bond fund for central bank investments. This green bond fund initiative will aid central banks in managing their reserves by incorporating environmental sustainability objectives.
The open-ended fund promotes green finance by pooling BIS client assets through a fund and creating “sizeable climate-friendly investments” using best market practices. An advisory committee composed of a global group of central banks was created in support of the fund. “The initiative is part of the BIS's broader commitment to supporting environmentally responsible finance and investment practices, in line with the Bank's participation in the Central Banks and Supervisors.”
The Network for Greening the Financial System, First Comprehensive Report, was published in April 2019, by eight central banks and supervisors who established a Network of Central Banks and Supervisors for Greening the Financial System (NGFS). The report states that NGFS members acknowledge that “climate-related risks are a source of financial risk. It is therefore within the mandates of central banks and supervisors to ensure the financial system is resilient to these risks.” NGFS now includes 34 central banks and supervisors, and five observers, including BIS; and recently, the Basel Committee agreed to join NGFS as an observer, indicating the relevance and importance of environmental finance issues for years to come.
In July 2019, the Financial Stability Institute (FSI) of the Bank for International Settlements (BIS) published a study of the application of proportionality under Pillar 2 of the Basel framework. Sixteen jurisdictions were surveyed to examine their application of proportionality and how they implemented Pillar 2 principles. FSI stated that the key aim of the survey was, "to determine whether and, and if so, how supervisory authorities apply proportionality in tailoring risk management expectations and supervisory practices according to the size, complexity and risk profile of regulated entities."
The Basel Committee on Banking Supervision created a three pillar approach to the oversight of international banks, designating Pillar 1 to outline risk-based capital (RBC) rules, which are subject to supervisory review pursuant to Pillar 2 regulatory requirements and disclosure requirements set forth in Pillar 3. Pillar 2 requires an assessment of risk profile through a cumulative set of risk management requirements coupled with risk-based supervision (RBS).
FSI's "Proportionality Under Pillar 2 of the Basel Framework", can be found here.
The BIS’s Financial Stability Institute (FSI) and the G20s Global Partnership for Financial Inclusion (GPFI) convened a conference to discuss the implications of fintech for financial regulation and supervision and the work of the various standard setting bodies.
Participants explored specific examples of adapting regulatory, supervisory and safety net practices to take into account fintech developments; ways for financial sector authorities to leverage the same technologies driving fintech to support their own work; and the application of the concept of proportionality in the implementation and assessment of international standards.
The conference took place in the context of accelerating change in the financial services landscape in countries across the income spectrum, including expanding opportunities for financial inclusion, but also new challenges for country-level authorities and for standard setting bodies. Further coverage of this event can be found here.
WOCCU has been active surrounding developments in regulation concerning fintech most recently urging the Global Financial Innovation Network (GFIN) to ensure a level regulatory playing field for credit unions as well as including the principles of proportionality in connection with GFIN’s proposal to create a regulatory “global sandbox” for fintechs. A copy of this letter can be viewed here.
The Group of Central Bank Governors and Heads of Supervision (GHOS), the oversight body of the Basel Committee on Banking Supervision, announced that agreement has been reached on the finalisation of Basel III. The agreement improves the comparability of banks’ risk-weighted assets and reinforces the credibility of the bank capital framework. Agreement on these final elements means that key reforms pursued to address the causes of the global financial crisis has now been completed and can be fully implemented.
The reforms include the following elements:
- an aggregate output floor, which will ensure that banks' risk-weighted assets (RWAs) generated by internal models are no lower than 72.5% of RWAs as calculated by the Basel III framework's standardised approaches. Banks will also be required to disclose their RWAs based on these standardised approaches. (Advocated for by WOCCU which should help level the competitive playing field for credit unions and other community-based financial cooperatives
- a revised standardised approach for credit risk, which will improve the robustness and risk sensitivity of the existing approach;
- revisions to the internal ratings-based approach for credit risk, where the use of the most advanced internally modelled approaches for low-default portfolios will be limited;
- revisions to the credit valuation adjustment (CVA) framework, including the removal of the internally modelled approach and the introduction of a revised standardised approach;
- a revised standardised approach for operational risk, which will replace the existing standardised approaches and the advanced measurement approaches;
- revisions to the measurement of the leverage ratio and a leverage ratio buffer for global systemically important banks (G-SIBs), which will take the form of a Tier 1 capital buffer set at 50% of a G-SIB's risk-weighted capital buffer; and
A summary of the agreed reforms can be found in the summary document and the final text can be viewed here. The revised standards will take effect from January 1, 2022 and will be phased in over five years.
The Monitoring Group, consisting of public authorities responsible for monitoring the international audit standard-setting process (the International Organization of Securities Commissions (IOSCO), the Basel Committee on Banking Supervision (BCBS), the European Commission (EC), the Financial Stability Board (FSB), the International Association of Insurance Supervisors (IAIS), and the World Bank Group (WBG)), has issued a consultation paper setting out options to enhance the independence, relevance and transparency of international audit standard setting in the public interest.
The consultation paper focuses on the governance and structure of the Standard Setting Boards (SSB) that support auditing as a public interest activity, namely the International Auditing and Assurance Standards Board and the International Ethics Standards Board for Accountants. The proposal is far-reaching, setting out the main areas of concern regarding the current structure and considering, among other matters, the number, remit and size of the SSBs and their staffs; the accountability of the SSBs to International Federation of Accountants (IFAC); the process for nominating members to the SSBs; the roles of the Public Interest Oversight Board and the Monitoring Group; and the means by which the structure is funded.
Comments on the Consultation are due February 9, 2018 and can be viewed here.
Basel Committee Secretary General Indicates Willingness to Fine-Tune Basel Rules to Reduce Reg Burden2017-11-03
Basel Committee Secretary General William Coen indicated in recent public remarks that the Basel Committee is willing to fine-tune its international standards to reduce unintended regulatory burdens. Mr. Coen's remarks were made at the 2017 Institute of International Finance's Annual Membership Meeting in Washington, DC.
Secretary Coen confirmed that “there is likely to be a period during which no further major policy initiatives will be undertaken” by the Basel Committee once the Committee finalizes the rest of their Basel III-related rulemakings: (a) Revisions to the Standardised Approach for credit risk; (b) Standardised Measurement Approach for operational risk; (c) Reducing variation in credit risk-weighted assets – constraints on the use of internal model approaches; and (d) Revisions to the Basel III leverage ratio framework.
Toward the end of the remarks Secretary Coen implies that since the Basel Committee is not certain exactly certain how the new Basel III standards will work in practice (since phase-in is technically in January 2018 for most Basel III rule), the Committee will be open to fin-tuning the standards if they turn out to have unintended consequences.
Also included are comments from Svein Anderson, Secretary General of the Financial Stability Board on a ongoing research project on the effects of reform that, once finalized, "will be an evidence-based starting point for discussing potential deregulatory changes especially with respect to lending to small and medium enterprises (SMEs) and long-term financing."
The entire update can be viewed here. WOCCU will continue to monitor and engage on these and other issues as they progress.
The Basel Committee on Banking Supervision has proposed a simplified alternative to the market standardized approach in an effort to facilitate
Use of the proposed “Simplified Alternative” would be subject to national supervisory approval and oversight, and available only to smaller, less complex banks or credit unions. The proposal includes a simplified version of the sensitivities-based method (“Standardized Approach”) which is the primary component of the Standardized Approach. The Basel Committee last updated the standardized approach to market risk in January of 2016
WOCCU's initial summary and analysis of the proposal can be found here.
Please provide comments to Andy Price, Regulatory Counsel at email@example.com by September 21, 2017.
Reduced compliance burdens for community-based financial institution are closer to reality with new guidance on “proportional” regulation from the Bank for International Settlements. The Financial Stability Institute, the arm of Bank for International Settlements that promotes regulatory consistency across jurisdictions, on August 3rd issued new guidance clarifying when supervisors are allowed to deviate from international financial rules in order to reduce burdens on community-based financial institutions.
The guidance shows the range of approaches used to achieve “proportional” regulation in Brazil, the European Union, Hong Kong, Japan, Switzerland and the USA. “National-level supervisors are supposed to apply international financial regulatory standards ‘proportionally’ to smaller, less complex institutions like credit unions, but it was not always clear what ‘proportional’ meant in practice” said Michael Edwards, vice president and general counsel of World Council. “This new guidance provides national-level regulators with examples of compliance burden reduction ‘proportionality’ in six G20 economies that supervisors have discretion to adopt in any jurisdiction.” Concurrently, the Financial Stability Institute also issued new guidance on cyber-risk.