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Opinion 22 April 2020

The regulatory response to COVID-19

Matías Cabrera and Pilar Soler, from BBVA’s Regulation team, analyze the measures launched by regulators to mitigate the economic impact of the coronavirus crisis. In their opinion, “unlike during the preceding crisis, banks today have the opportunity to be a part of the solution, although this will require great cooperation between incumbents and authorities to ensure a speedy recovery”.

The economic consequences of the health crisisz created by the COVID-19 outbreak have prompted national and international regulatory authorities to take agile and forceful measures. These measures underline the essential role that banks play as providers of financing under extraordinary circumstances such as the currently unfolding one, which is placing a strain on liquidity. The set of measures announced by different regulators and authorities will allow institutions to channel their efforts and resources more efficiently and swiftly to contribute to boost economic recovery prospects.

Among the measures announced by European agencies, probably the most relevant are the ones related to aimed at encouraging institutions to use their prudential capital and liquidity buffers. International organizations view these measures as positive, and both the Basel Committee and the Financial Stability Council have urged incumbents to leverage the flexibility allowed by global standards.

This flexibility will allow financial institutions to devote more resources to stimulate the real economy. Such is the case of the European Central Bank (which is the supervisor of the largest financial institutions in the banking union), which has announced that it will allow banks to use their capital and liquidity buffers. In the same line, the European Banking Authority (EBA) has reminded institutions that the capital and liquidity buffers are to be used in periods of crisis to uphold lending levels, particularly considering that compared to the previous financial crisis, the banking system’s capital position is much stronger.

Banks today have the opportunity to be a part of the solution, although this will require great cooperation between incumbents and authorities to ensure a speedy recovery

These measures are intended to maintain and, if necessary, expand lending activity under exceptional circumstances. But this expansion necessarily entails an adequate recognition of potential impairments. On this matter, both prudential and accounting authorities, including the International Accounting Standards Board, have made it clear that the flexibility instilled in rules should be put to use, so as to avoid the automatic reclassification of exposures (which would have a significant prudential impact in the form of higher provisions).

These statements are important, since they will allow lenders to recognize that many of the impairments are the result of a very particular situation, one that may not have necessarily compromised borrower’s solvency. This is particularly relevant in cases where moratoriums of payments have been decreed for specific loans: accounting standards should not be applied mechanically, to prevent these loans from being automatically reclassified as non-performing or defaulting. On this subject, the EBA recently published a set of guidelines that will help determine whether, in the event of a – statutory or otherwise – moratorium, the necessary conditions are met avoid the classification of exposures under the definition of forbearance or as defaulted under distressed restructuring.

Finally, operational measures have also been adopted to relieve entities of some of the operating burden derived from regulatory and supervisory processes, to allow them to focus on their main activity, lending. Thus, the EBA has decided to postpone the EU-wide stress test exercise to 2021. The ECB has also rescheduled the implementation date for some supervisory decisions and the Basel Committee has postponed the implementation of the final framework of Basel III by one year.

However, what the final impact of the crisis will be remains uncertain. Unlike during the preceding crisis, banks today have the opportunity to be a part of the solution, although this will require great cooperation between incumbents and authorities to ensure a speedy recovery. The latest meeting of the Council of the EU stresses this issue: authorities should take ambitious and coordinated measures in order to prevent that the level playing field among Member States is harmed. As in all crises, we also have lessons to learn, in this case perhaps the most important is that capital buffers are there to be used. But we cannot forget either that, once again, some of the weaknesses of the European Union have been laid bare, especially the fragmentation of the banking system that has been reflected in a plethora of differing national measures, but with very little shared risk-taking at euro area level, which underscores the importance of completing the Banking Union with a European deposit insurance scheme.

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