The Financial Stability Institute (FSI) of BIS published a brief note that examines the supervisory challenges associated with certain temporary regulatory relief measures introduced by BCBS and prudential authorities in response to the COVID-19 pandemic. These temporary relief measures introduced by governments and banks include public guarantees and payment deferrals to support struggling borrowers. The note highlights that the most consequential challenge for prudential authorities will be how and when to exit from these exceptional regulatory relief measures, particularly if credit risks continue to mount on bank balance sheets.
The note briefly summarizes key features of the public guarantees and payment deferral schemes, how COVID-affected borrowers that have been granted debt relief are classified under the BCBS prudential guidelines on problem assets, and how such exposures and the related expected credit loss (ECL) provisions are considered in calculating regulatory capital. It then examines the implications of regulatory relief measures on key prudential metrics and outlines the supervisory challenges arising from these relief measures. In view of these challenges, the note describes the following practical steps that prudential authorities can take to enhance their supervisory risk assessments and to support banks’ efforts to reflect credit risk in their reported regulatory measures:
- Ensure that banks proactively utilize the UTP criterion—independent of public guarantees—to determine the stock of reported nonperforming exposures
- Assess, under Pillar 2, whether the minimum Pillar 1 credit risk capital requirements under the standardized and internal ratings-based approaches are sufficient in relation to a bank’s stock of nonperforming exposures and other low-quality assets
- Determine the cumulative amount and realizability of the “interest accrued but not collected” line item associated with borrowers granted payment deferrals
- Provide guidance to banks on how to reflect the impact of partial guarantees that may be provided to incentivize lending to affected borrowers, for the purpose of calculating risk-based capital requirements
- Encourage banks to consider using, where appropriate, other forms of credit modifications, such as principal haircuts—rather than relying solely on payment deferrals that must be repaid—particularly for borrowers that have already been identified as unlikely to pay their rescheduled debts
The note highlights that, as long as the fallout from the pandemic continues, these temporary relief measures are likely to remain in the prudential framework, while credit risks continue to mount on bank balance sheets. This dichotomy poses risks to financial stability, particularly if credit losses materialize after the payment holiday period ends and the regulatory relief measures can no longer prevent heightened credit risks from being fully reflected in a bank’s reported level of non-performing exposures and common equity tier 1 risk-based capital (CET1 RBC) ratio, both of which are widely used benchmarks to assess the health of banks and national financial systems. The conclusion is that, going forward, the most consequential challenge for prudential authorities will be how and when to exit from these exceptional regulatory relief measures. Acting too early may be counterproductive and could exacerbate a credit crunch, while waiting too late may undermine confidence in the regulatory regime and threaten systemic stability. As with all difficult decisions in prudential supervision, making the right calls, at the right time will involve the use of sound judgment; the judgments made, particularly in these unprecedented times, can have a ripple effect on the wheels that grease the global economy
Keywords: International, Banking, COVID-19, Loan Guarantee, Payment Deferrals, Credit Risk, Regulatory Capital, ECL, NPE, Basel, FSI, BIS
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