Patterns of regulatory initiatives amid funding stimulus and preservation of resilience
European Securities Markets Authority, Paris
Report on Banking Law Committee webinar
Friday 28 May 2021
Jean-François Adelle Jeantet, Paris
Klaus Löber ESMA, Frankfurt
Francesca Passamonti Intesa Sanpaolo, Brussels
Kai-Michael Hingst Noerr, Hamburg
Christian Scarafia Fitch Ratings, London
Andreas Schirk Financial Services and Capital Markets Union, European Commission, Brussels
This webinar was the second in an ongoing series of webinars organised by the Banking Law Committee regarding the impact of the pandemic in the financial arena. Jean-François Adelle introduced the panel with a picture of the challenging impact of Covid-19 on financial regulation patterns. It has caused a violent shock to markets, provoking an unprecedented monetary and budgetary response, which sought to stabilise the economy while also aiming to maintain banks’ robustness through their loan portfolios. He laid out three points to be discussed during the session:
- how regulation and its implementation have been wielded to strike the aforementioned balance;
- how regulated institutions have behaved in this environment; and
- what regulation’s role is in planning for a ‘return to normal’.
Andreas Schirk took up the first point, explaining how the reforms following the global financial crisis of 2007–8 left the banking industry in the EU far better prepared, through greater funding and therefore resilience, to weather the economic impact of the Covid-19 crisis. The European Commission also responded with a package proposing targeted amendments to the banking prudential framework and the Capital Requirements Regulation (CRR), adding flexibility to the interpretation of rules regarding non-performing loans (NPLs), guarantees and moratoria, leverage ratios and loan loss provisioning. A further NPL strategy was presented at the end of 2020, including a draft Directive aiming to bolster liquidity and transparency in secondary markets and advice on Member States’ establishment of asset management companies, while efforts were also made to improve loan servicing efficiency and insolvency frameworks.
Kai-Michael Hingst then gave his perspective on the national-level response of the German banking industry. The German financial regulator BaFin lowered the countercyclical capital buffer to 0 per cent of total exposure early in the crisis to increase flexibility for banks. In addition, to prevent detrimental cyclical effects of multiple banks making simultaneous variation adjustments, the International Financial Reporting Standards (IFRS) setter, European regulatory authorities and BaFin made clear that neither the economic situation nor the acceptance of state aid packages would result in an automatic adjustment of this kind in the case of expected losses. Hingst also mentioned the important impact of German development bank KFW’s sizeable government-guaranteed loans and relaxing of debt servicing requirements.
Francesca Passamonti, bringing the perspective of the Italian market, conveyed her appreciation of the prompt and coherent regulatory responses for dampening the shock of the crisis and the role of policy in encouraging sustainable economic growth under the EU’s Multiannual Financial Framework. In the case of Intesa Sanpaolo, the relevant developments were comparatively limited, including the anticipated entry into force of the standards for prudential treatment of software. On the supervisory side, the picture is mixed; Passamonti said that she would have preferred to see an extension of the applicability of Article 500 of the CRR, allowing mitigation of the impact in case of massive disposals of NPLs.
Christian Scarafia, on the other hand, reminded the panel that, though banks entered the crisis in a fairly strong position with improved capitalisation and reduced rates of NPLs, many European banks were encountering structural issues affecting profitability even before the onset of the pandemic. This led Fitch Ratings to revise their sector outlook for Western Europe to negative even in December 2019.
Regarding big banks’ reactions to regulation and the crisis at large, Scarafia noted the number of ratings downgrades of banks was relatively limited due to a number of measures, including provision of liquidity by central banks, government guarantees, prudential measures regarding capital buffers and temporary relief on credit losses for stage 1 and 2 loans under IFRS 9.
Passamonti clarified her bank’s role in independently allowing debtors time to pay and providing support to key sectors of Italian society such as the tourism industry, students, households and female entrepreneurs. Internally, Intesa Sanpaolo had to streamline its systems to process thousands of loan requests, not always under standard lending procedures, while the Italian government legislated via decree to react to the ongoing situation.
Addressing the German response, Hingst pointed out that a key aspect was the dialogue between financial institutions and the regulator, including BaFin’s recommendations not to use share buyback programs or distribute dividends and to consider whether bonuses were appropriate. Schirk then picked up on the question of the usability of capital and liquidity buffers, asking whether banks’ tendency to sit on their capital indicates an inadequacy of the current framework as well as a possible need to overhaul current models for estimation of market risk. Additionally, there have been large discrepancies in low loss provisioning among European banks, and between them and their US peers, leading Schirk to strongly recommend an in-depth analysis of the lessons to be learnt from these diverse approaches once the dust has settled on this crisis.
Klaus Löber remarked that a common pattern among the panellists’ contributions was that short-term problems have been quite effectively managed, while longer-term issues are yet to be resolved.
This led onto the third point addressed in the discussion, namely the picture looking forward towards a possible ‘return to normal’. Scarafia made clear the general expectation of a relatively speedy recovery in the second half of 2021 as banks will need to be discerning regarding performing loans and not artificially prop-up the ‘zombie’ economy. One real difficulty, he said, is modelling the current, somewhat unique environment, including the impact on NPLs as payment holidays come to an end. Passamonti noted that NPLs will inevitably increase from their currently low levels and that there will be a need for more selective support of viable sectors most hit by the pandemic, including the so-called ‘restaurant culture’.
In Germany, according to Hingst, much will depend on the effect of the new BaFin president taking up office and of the general elections in September 2021, which could determine either a more conservative or liberal funding and tax policy in the next few years. Schirk, on the other hand, mentioned the discussions between the European Commission, providers (including banks and insurers), consumers and households aimed at ensuring that the post-crisis build-back fosters viable restructuring as we start to encounter the significant solvency issues facing European companies. Sustainability, he argued, is the buzzword that will define much of the economic recovery from the effects of Covid-19.
In response to the audience’s questions, Scarafia pointed out that Western European banks have a particularly negative outlook when compared with North America, Eastern Europe and other regions. Schirk discussed the role of Covid-19 in the postponement of the finalisation of Basel III, also clarifying the necessity of the Basel accords and international commitment to their implementation before the end of the decade.
Passamonti and Hingst finally brought the lively and enlightening discussion to a close with some brief comments regarding the growth of deposits in bank accounts over the course of the crisis and the importance of cross-border coordination, including the United Kingdom, in a European comeback after this era-defining crisis.