The COVID-19 Banking Package: More flexibility in the EU’s banking rules
On 28 April 2020, the European Commission proposed a package of legislative measures to facilitate bank lending in response to the Coronavirus crisis. The package contains a number of amendments to the Second Capital Requirements Regulation (CRR II):
- The 5-year transition‑period for the application of the Expected Credit Loss (ECL) method for recognising non‑performing exposures and calculating loan loss provisions in accordance with IFRS 9 is to be reset by two years, from 01 January 2018 to 01 January 2020, and shortened by one year. Originally, full transition to IFRS 9, including the introduction of a compulsory threshold for recognising a non-performing exposure (the so-called „prudential backstop“), was expected to be completed by 01 January 2023. Now, its introduction is to be postponed by one year, to 01 January 2024. During the transition banks may add back a (decreasing) portion of IFRS 9 provisions to CET1 (Art. 473a CRR II);
- The application of the Leverage Ratio buffer requirement for global systemically important banks (G‑SIBs) (Art. 92 CRR II) is to be postponed by one year (to 01 Jan 2023). Supervisory authorities may grant temporary permission to banks, for a period of up to one year, to exclude reserves held with central banks (not including sovereign bonds) from the calculation of the Leverage Ratio (Art. 429a CRR II);
- Amendments to the credit risk support factor for loans to small and medium-sized enterprises (SMEs) (Art. 501 CRR II) and the introduction of a new support factor for infrastructure projects (Art. 501a CRR II.) are to be brought forward by one year; and
- A new rule that no longer requires banks to deduct intangible assets related to investment in software from regulatory capital (Art. 36 CRR II) is to be brought forward by one year (i.e. to become effective on the date of the proposed amending Regulation).
Other EU initiatives to support bank lending
The proposed legislative initiative does not stand alone but comes in addition to a raft of other monetary, regulatory and supervisory measures:
- On March 12, the European Central Bank (ECB) allowed banks to operate temporarily below the level of capital defined by Pillar 2 Guidance (P2G), the capital conservation buffer (CCB) and the liquidity coverage ratio (LCR) and called on the national macroprudential authorities to relax the countercyclical capital buffer (CCyB). The ECB also provided for the (partial) use of capital instruments that do not qualify as Common Equity Tier 1 (CET1) capital (e.g. Additional Tier 1 or Tier 2 instruments) to meet Pillar 2 Requirements (P2R).
- On 18 March, the ECB announced a new, expanded asset purchasing programme totalling € 870 billion, the Pandemic Emergency Purchasing Programme (PEPP), to stabilise the banking sector and encourage banks to extend loans to companies and households throughout the present crisis.
- On 19 March, the European Commission published a temporary framework for State Aid. With reference to Art. 107 TFEU, the Commission confirmed that:
- State Aid granted by member states to businesses, when channelled through banks as financial intermediaries, benefits those businesses directly and does not have the objective to preserve or restore the viability, liquidity or solvency of banks. It is therefore not to be considered as State Aid to the banks;  and
- State Aid granted by member states to banks to compensate for direct damage suffered as a result of the COVID-19 outbreak does not have the objective to preserve or restore the viability, liquidity or solvency of an institution or entity and therefore does not qualify as extraordinary public financial support.
- On 25 March, the European Banking Authority (EBA) issued a statement on the application of the prudential framework regarding default, forbearance and the application of IFRS 9 in light of COVID-19 measures. This was one of a several statements by the EBA in support of initiatives by national governments and supervisory authorities to soften the impact of the crisis, in particular by decreeing, or facilitating, a suspension or delay of loan repayments by households and businesses. The EBA confirmed that such moratoria should not be considered as forbearance measures and loans that benefit from a suspension should not automatically be reclassified as defaulted.
- On 01 April, the Single Resolution Board (SRB) announced that it would „use its discretion and the flexibility given by the regulatory framework to adapt transition periods and interim targets applied to banking groups, as well as to adjust MREL targets in line with capital requirements, with particular reference to capital buffers.“
Finance Watch’s view on the CoViD-19 Banking Package
Fundamentally, Finance Watch agrees that it is sensible not to insist on tightening the rules in the middle of a crisis. COVID-19 can be seen as an archetypal „external shock“ to the economy – unlike in 2008, this crisis is not self-inflicted. Just like in 2008, banks will suffer severe losses and have difficulties raising fresh capital. From the point of view of counter-cyclical policy-making, it makes good sense to suspend or postpone measures that aim at increasing the resilience of banks in advance of a crisis, and to bring forward others that are meant to support lending to the real economy when the crisis has arrived. But there are limits:
- The proposed legislative measures come on top of a host of other measures already put in place by other EU institutions, national governments and supervisors. The banking sector now has plenty of incentives to extend credit: liquidity is abundant and free, due to the ECB’s huge asset purchase programme (PEPP); existing regulatory capital can be levered, due to the regulatory relief provided by supervisors; lastly, the recognition of, and provisioning for, likely loan losses may be postponed.
- The result of this combination could be a further decline in lending standards – which have been weak already prior to the pandemic – and, ultimately, a resurgence of NPLs. A new wave of NPLs, including from borrowers who were barely solvent even before the pandemic, would perpetuate the already existing NPL problem and raise the clamour, once again, for a taxpayer bail-out of the worst-affected, and usually poorest-run, banks.
- We disagree, therefore, with the proposal to reset the timeline for introducing IFRS 9. It does not only postpone the introduction of a sorely needed, and long overdue common approach towards recognising non-performing loans and provisioning for losses but deprives regulators, investors, and all other external stakeholders of a key metric of the health of banks‘ balance sheets, at a time when it is most needed.
- There is always a risk that provisional measures end up becoming permanent: as we have seen, for instance, with the infamous Banking Communication of 2013, a crisis measure that survived all the way through the „greatest bull market in history“ (2009-2020), nothing lasts longer than a temporary fix. With IFRS 9, a measure that was fiercely resisted by the banking industry every step along the way, the risk of regulatory backsliding must be considered very real.
- Finally, all the support provided to the banking sector by taxpayers deserves a „quid pro quo“. If legislators are expected to relax the rules in order to help banks extend credit without running into capital constraints, it would only be fair to expect them to commit to conserving capital in turn. The recommendation of the ECB and EBA for banks to forego any distributions to shareholders (dividends, buy-backs, AT1 coupons) and discretionary payments to staff (bonuses) should be made compulsory for as long as the capital relief measures are in force.
As we collectively pick our way out of this crisis, we should perhaps pause for thought and consider what the benchmark for the resilience of firms that we consider critical for the functioning of our economy – in the banking sector and beyond – ought to be. Do we expect them to be set up so that they are just about stable in fair weather or do we expect them to be able to tide themselves over major crises – and not only those that are of their own making? At Finance Watch, we feel strongly that private risk and return should be properly aligned, not only in the textbooks. As of today, though, privatising profits and socialising losses still appears to be the preferred policy response.
Christian M. Stiefmüller