Information current at 20 March 2020
The COVID-19 situation has rapidly upended the workforce and the economy. Banks have an essential role to play in the government-led efforts to help households and businesses deal with the immediate shock and its aftermath. At the same time and in the same way as all organisations, banks face their own challenges - managing the health and wellbeing of their workforce and ensuring continuity of operations, as social distancing policies are implemented, members of staff become ill or self-isolate, and as the relative demand for access to financial services across different channels changes.
The immediate focus of banks is currently on three outcomes:
- ensuring resilience of their operations, and continuity of access to financial services for their customers;
- preparing to manage liquidity shocks or increased volatility in capital markets; and
- helping borrowers manage through the economic disruption.
Operational resilience is very high on banks’ agenda, for at least three reasons. First to understand how digital channels will cope in terms of peak usage. Second, to ensure that there is a swift and assured response to any operational disruption, particularly one that might be misconstrued in the market or by customers as financial disruption. Third, there is a strong focus on key third party suppliers on which large numbers of banks depend. Banks have also had to put into practice their own business continuity plans and in the process deal with the specific characteristics of this disruption. For example, rather than relocating teams to pre-prepared back-up sites most individuals are working remotely from home.
Regulatory and supervisory response
During the past week the Financial Conduct Authority (FCA) and Bank of England (BoE) have announced sweeping delays to policy development and regulatory change programmes, and will reduce the workload for individual firms from supervisory programmes. These actions will provide banks with much-needed breathing space in the short term in order to focus on the outcomes highlighted above. That said, the initiative to transition to sterling risk-free rates from LIBOR is notably absent from the announcements so far, and work to meet the existing deadlines that the FCA and BoE have set will need to continue.
The measures that we have seen so far fall into five broad categories:
- Central bank and government credit facilities. HM Treasury (HMT) launched a COVID Corporate Financing Facility, which will provide funding to businesses by purchasing commercial paper; and the BoE Monetary Policy Committee launched a new term-funding scheme with additional incentives for lending to SMEs.
- Reduction in capital requirements, and a general exhortation that buffers are there to be used, both capital and liquidity. The BoE Financial Policy Committee (FPC) reduced the UK countercyclical capital buffer rate to 0% of banks’ exposures to UK borrowers. The FPC and Prudential Regulation Committee (PRC) also reminded banks that capital – and liquidity – buffers may be drawn down as necessary through this temporary shock, although in that case banks should not increase dividends or other distributions.
- Measures to ease compliance with existing rules. The FCA and BoE identified a number of areas where they could be flexible in the application of rules, whilst underscoring that banks must still act to meet regulatory requirements. One example is market trading and reporting, where the FCA recognised that there may be scenarios that emerge where it is not possible for banks to record all calls. The BoE provided initial guidance on the use of forward-looking information to incorporate the impact of COVID-19 on borrowers into the expected credit loss estimate for the purposes of IFRS9 , and expects to provide further guidance.
- Measures to ensure ongoing fair treatment of customers, especially vulnerable customers. The FCA reminded firms that its rules already provide flexibility in a number of areas and that it expects firms to use this to support consumers, bearing in mind customers’ individual circumstances. It said that it welcomed firms taking initiatives that go beyond usual business practices. We expect that firms’ treatment of vulnerable customers to be a particular focus.
- Measures to alleviate the operational burden on firms to enable them to prioritise dealing with the current challenges. The FCA delayed or postponed activity “which is not critical to protecting consumers and market integrity in the short-term”, including extending the closure dates for many of its published consultations. The BoE took similar action, announcing the cancellation of the 2020 Annual Cyclical Scenario (ACS), the postponement of the publication of the results of the 2019 Biennial Exploratory Scenario (BES) on liquidity and next steps on the 2021 BES on climate change, and an extension to the consultation period for its consultation papers on outsourcing and operational resilience. It also postponed non-critical supervisory visits and deadlines for individual firms.
There are additional measures that the government has introduced to stabilise the impact on the broader economy. These should also assist banks in managing through this changing and difficult environment.
Implications for banks, and further options available to supervisors and regulators
This is unlikely to be the final word. We expect regulators and supervisors will continue to reprioritise their objectives. The BoE said that the new Financial Services Regulatory Initiatives Forum (announced last week by the Chancellor) will meet for the first time as early as April. The publication of the Regulatory Initiatives Grid after that meeting will give a key insight into future timelines.
The BoE has said it will review the timetable for the climate change BES in the summer. And with COP 26 taking place at the end of this year, we think there will still be appetite to make more progress on the BoE’s climate risk agenda – although there have also been rumours reported in the press that COP 26 might be postponed.
More broadly, regulators and supervisors will think carefully about which regulatory change projects do need to continue in order to maintain financial resilience and stability, protect customers and to avoid derailing medium-term initiatives. We also expect regulators to favour transparency of actions over “turning a blind eye”, on the basis that transparency is most likely to maintain or, where needed, restore confidence in banks and in the financial system.
Supervisory scrutiny of key institutions and risks will also increase, but at a distance given that it is not possible to do on-site surveillance. As was the case during the financial crisis, supervisors will want to see higher frequency reporting in some areas, for example measures of liquidity or credit exposure to certain sectors; and will scrutinise contingency funding plans including to assess whether recovery options are valid or effective in the current environment.
One step that supervisors in the UK may be slower to take is imposing restrictions on short-selling. The European Securities and Markets Authority and competent authorities in other EU jurisdictions (including France, Italy, Spain and Belgium) have put measures in place either to restrict or ban short-selling. Although the FCA has extended those other regulators’ restrictions to the UK, it has so far refrained from action of its own. For now it seems that the UK authorities’ primary objective is to keep markets open for as long as they continue to function in an orderly manner.
It remains to be seen how comfortable banks will feel running down capital buffers, and supervisors may need to take further steps to incentivise this outcome. Banks are much stronger than they were during the financial crisis – and so in principle, there should be no obstacle to them using the capital and liquidity – but shareholders and bondholders may have different perspectives. Moreover, banks may themselves be cautious about releasing too much of their buffers too soon. Even if the economic shock from COVID-19 is temporary, there is significant uncertainty about the outturn. The PRA may though have limited further options beyond guidance and assurances about its approach. It is also likely to be particularly cautious about suspending measures which deal with known capital and liquidity deficiencies, especially on an individual bank basis.
It is also important to keep in mind that in most cases measures have been delayed but not cancelled – at least, not yet. Banks had anyway been under considerable pressure to hit milestones, for example for IRB models programmes and to be ready to run the 2021 BES. They can now reduce speed, but not stop making progress. On operational resilience, the delay is only to the implementation of the new framework and does not remove the pressing need for banks to be operationally resilient.
The indication from the BoE that implementation of Basel 3.1 might be delayed internationally is a major further development to watch.
What is next?
The situation is developing very rapidly, and to some extent unpredictably. Regulatory and supervisory responses will be driven by a combination of government action, what is happening to the economic activity, the volatility of financial markets, the functioning of key financial market infrastructure and the needs of customers, particularly those in financial distress. Above all, we think that the BoE and PRA will do what they can to prevent a repeat of the liquidity and credit crunch which was so damaging to the economy and the financial system in the aftermath of the financial crisis.
Banks need to be ready to respond at short notice to supervisory requests for additional and in some cases detailed information about emerging risks and vulnerabilities. This will in turn require enhanced risk management and monitoring. Banks that can deploy tactical scenario testing and have a well-developed set of early warning indicators for operational disruption; customer distress; market events; and contingency planning activation triggers will be well placed to meet the needs of supervisors – and also their full range of stakeholders.
For further discussion of these issues you might be interested to read a recent article from Deloitte on COVID-19 potential implications for the banking and capital markets sector: Maintaining business and operational resilience.