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    ECB Clarifies Extension and Cessation of Policies Amid COVID Pandemic

    July 28, 2020

    ECB extended its recommendation to banks on dividend distributions and share buy-backs until January 01, 2021. ECB recommended for banks to be extremely moderate with regard to variable remuneration and clarified that it will give enough time to banks to replenish their capital and liquidity buffers to not act pro-cyclically. ECB also issued a letter to banks communicating its expectations that banks should have in place effective management practices and sufficient operational capacity to deal with the expected increase in distressed exposures. In the context of these newly issued recommendations, ECB also updated the frequently asked questions (FAQs) on the supervisory measures announced to ease the impact of COVID-19 pandemic.

    The updated recommendation on dividend distributions remains temporary and exceptional and is aimed at preserving banks’ capacity to absorb losses and support the economy in this environment of exceptional uncertainty. This uncertainty makes it difficult for banks to accurately forecast their capital positions. Analysis shows that the level of capital in the system could decline significantly if a severe scenario were to materialize. ECB will review whether this stance remains necessary in the fourth quarter of 2020, taking into account the economic environment, the stability of the financial system, and the reliability of capital planning. Once the uncertainty requiring this temporary and exceptional recommendation subsides, banks with sustainable capital positions may consider resuming dividend payments. This will also apply when they are operating below the Pillar 2 Guidance capital level. As a precondition, banks’ projected capital trajectories must demonstrate that their capital positions are sustainable in the medium term.

    To preserve banks’ capacity to absorb losses and support lending to the real economy, ECB also issued a letter to significant banking institutions asking them to be extremely moderate with regard to variable remuneration payments, for example, by reducing the overall amount of variable pay. Where this is not possible, banks should defer a larger part of the variable remuneration and consider payments in instruments such as own shares. As usual, ECB will continue to assess banks’ remuneration policies as part of its Supervisory Review and Evaluation Process (SREP), specifically the impact that such policies may have on a bank’s ability to maintain a sound capital base. The ECB approach on dividends and remuneration complies with the related ESRB recommendations from May 2020. This letter also aims to clarify operational expectations of the ECB Banking Supervision on the management of the quality of loan portfolios so that significant institutions can better provide this financial support to viable businesses that have or may come under distress as a result of the pandemic.The Joint Supervisory Team would appreciate to receive a response to this letter, approved by the board of directors, before September 15, 2020.

    Additionally, ECB continues to encourage banks to use their capital and liquidity buffers for lending purposes and loss absorption. It will not require banks to start replenishing their capital buffers before the peak in capital depletion is reached. The exact timeline will be decided following the 2021 EU-wide stress test, and, as in every supervisory cycle, on a case-by-case basis according to the individual situation of each bank. The same applies for replenishing the liquidity coverage ratio (LCR). ECB will consider both bank-specific (for example, access to funding markets) and market-specific factors (for example, demand for liquidity from households, corporate,s and other market participants) when establishing the timeline for banks to rebuild liquidity buffers. ECB commits to allow banks to operate below the Pillar 2 Guidance and the combined buffer requirement until at least the end of 2022 and below the LCR until at least the end of 2021, without automatically triggering supervisory actions.

    Finally, given that the banking sector has shown operational resilience, ECB does not plan to extend the six-month operational relief measures it granted to banks in March 2020, with the exception of non-performing loan (NPL) reduction strategies for high-NPL banks. ECB will once again start to follow up with banks regarding prior remedial actions following earlier SREP findings, on-site inspections, and internal model investigations. ECB also plans to resume the issuance of targeted review of internal models (TRIM) decisions, on-site follow-up letters, and internal model decisions once the six-month period is over. ECB will grant high-NPL banks an additional six months to submit their NPL reduction plans to provide banks with additional time to better estimate the impact of the COVID-19 pandemic on asset quality, which should enable more accurate planning. Banks are nevertheless expected to continue to actively manage their NPLs.

     

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    Keywords: Europe, EU, Banking, Basel, COVID-19, Dividend Distribution, Credit Risk, Liquidity Risk, Regulatory Capital, Capital Buffers, Pillar 2 Guidance, NPLs, FAQ, ECB

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