PRA provided further information on the application of regulatory capital and IFRS 9 requirements to payment holidays granted or extended to address the challenges arising from COVID-19 outbreak. Earlier, FCA had proposed guidance on how lenders should treat borrowers at the end of the initial deferral period, with the comment period ending on May 26, 2020. As a consequence, firms are assessing the capital and accounting treatment for exit from, and/or extension of, payment deferrals. The PRA statement sets out a high-level view on implications of this draft FCA guidance for certain regulatory measures announced by PRA in March 2020. The PRA statement also sets out views on accounting and regulatory definition of default. Consistent with the scope of the draft FCA guidance, the statement focuses on mortgage products.
In March 2020, PRA published guidance on the approach that should be taken by banks, building societies, and designated investment firms in assessing the expected loss provisions under IFRS 9. The current statement highlights that the PRA guidance has not changed for payment deferrals related to COVID-19 that are granted to borrowers for the first time; this includes existing payment deferrals granted prior to proposed guidance of FCA and the new payment deferrals granted to borrowers that have not yet had a payment deferral.
Borrowers coming to the end of an existing payment deferral will have different abilities to pay and varying financial situations. The proposed FCA guidance explains that, where borrowers are coming to the end of an existing payment deferral, lenders should distinguish between those who are able to resume full payments immediately and those who are unable to resume full payments due to circumstances arising out of the COVID-19 outbreak. The key judgment for regulatory capital and expected credit loss (ECL) purposes is whether the borrowers that do not resume full payments at the end of a payment deferral should be treated as in default (for Capital Requirements Regulation, or CRR), as having suffered a significant increase in credit risk, or as credit impaired (for IFRS 9).
Regulatory definition of default
For a borrower coming to the end of a payment deferral granted in accordance with the FCA guidance who is able to resume full payments, PRA would not expect such borrower to be regarded as being in default for CRR purposes, provided the payments are made under an agreed revised schedule. PRA does not consider the use of a COVID-19-related payment deferral granted in accordance with the proposed FCA guidance as triggering the counting of days past due or as generating arrears under CRR. PRA also does not consider the use of such a payment deferral to automatically result in the borrower being considered unlikely to pay under CRR. When assessing whether the borrower is past due on any material credit obligation owed to the institution or has any indicators of unlikeliness to pay, firms should make the assessment based on the agreed revised schedule of payments. This applies both to borrowers who are granted a further payment deferral under the terms of the proposed FCA guidance and to borrowers granted payment deferrals for the first time under the terms of the proposed FCA guidance.
Identifying whether a significant increase in credit risk or credit impairment has occurred for IFRS 9
A key judgment for ECL is how to account for the borrowers that do not resume full payments at the end of a payment deferral but are instead granted a further full or partial payment deferral. Eligibility for, and use of, COVID-19-related payment deferrals or extensions to those deferrals granted in accordance with the proposed FCA guidance would not automatically result in a loan being regarded as having suffered a significant increase in credit risk or being credit-impaired for ECL purposes. This is because the proposed guidance envisages that further payment deferrals can be used to manage short-term liquidity difficulties.
When assessing loans for evidence of a significant increase in credit risk or of the loan being credit impaired, it will continue to be important to distinguish borrowers using payment deferrals to manage temporary difficulties in making near-term payments from other borrowers. This is because some of the borrowers using payment deferrals to manage temporary difficulties in making near-term payments might not have suffered a significant increase in credit risk or be credit-impaired. However, as some will have suffered a significant increase in credit risk or be credit-impaired it will be important to consider other significant increase in credit risk and credit impairment indicators beyond whether the borrower is past-due. This will involve careful judgement as payment deferrals may be granted without the lender collecting detailed information about the circumstances of the borrower and might possibly involve high-level allocations of loans between the stages.
Comment Due Date: May 26, 2020
Keywords: Europe, UK, Banking, Securities, COVID-19, Regulatory Capital, IFRS 9, ECL, Accounting, Credit Risk, Definition of Default, CRR, Mortgage, Loan Repayment, FCA, PRA
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