EBA published thematic note presenting a preliminary assessment of the impact of COVID-19 outbreak on the banking sector in EU. The assessment concludes that COVID-19 outbreak is placing unprecedented challenges on EU banks. It highlights that banks have entered the COVID-19 crisis with strong capital and liquidity buffers and have managed the pressure on operational capacities. However, this crisis will have a negative impact on the asset quality of banks while the operational resilience of banks is under pressure. Banks have significantly increased their reliance on central bank funding and are expected to continue using their liquidity buffers in the coming months.
Banks have built material capital and liquidity buffers, not least driven by the post global financial crisis regulation. Although profitability remains subdued and nonperforming are still high in some countries, regulatory reforms applied over the past few years have allowed banks to enter this crisis with ample capital and liquidity cushions and a healthier funding mix. High liquidity coverage ratios and central bank support have allowed banks to weather the first months of the COVID-19 crisis without major liquidity concerns. Nonetheless, once banks restart the process to build up their Minimum Requirement for own funds and Eligible Liabilities, or MREL, they might face higher costs than in the pre-COVID-19 days, which will further increase pressure on profitability of banks. The following are the key conclusions of the EBA assessment:
- Asset quality. In the medium term, asset quality is expected to deteriorate significantly. The cost of risk has already started to rise and nonperforming loans are likely to surge by the end of the year. Banks have already started to book higher provisions in their first quarter financial statements. A sensitivity analysis considering transition rates from the 2018 EU stress test shows that the increase in credit risk could have an average impact of about –380 basis points in common equity tier 1 (CET1) ratio. The EBA Guidelines on loan moratoria set criteria aimed to avoid the automatic reclassification of affected loans as forborne or defaulted. However, banks will still need to carefully track asset quality, in particular of loans exiting the moratoria status. They should also identify any need for forbearance measures as quickly as possible and prevent unnecessary moves of performing exposures to non-performing status. State guarantees for loans, introduced in many jurisdictions, might soften the impact on balance sheets of asset quality deterioration.
- Capital levels. Although banks could face significant losses, capital buffers built prior to the pandemic and the relief provided by regulators and supervisors allow banks to provide relevant coverage for the rise in cost of risk and to maintain their important financing to the real economy. Even if 380 basis points of CET1 is depleted by credit risk-related losses, banks would, on average, retain a management buffer of nearly 1.1 percentage point above the overall capital requirement . Once this crisis is over, banks will have to rebuild capital buffers. Given their low market valuations, doing so inorganically might result in a high dilution for existing shareholders. The extent to which banks will be affected by the crisis is expected to differ widely, depending on, for instance, starting capital levels and operational efficiency as well as levels of exposure to the sectors more affected by the crisis. Competent authorities should quickly address any idiosyncratic weaknesses that could be exacerbated by the current crisis.
- Profitability. Profitability might remain subdued for an even longer period. Lending margins are likely to remain low as a result of the monetary stimulus by central banks. The expected credit quality deterioration will result in an increase in impairments. In addition, as many clients are now getting much more used to online banking, branch overcapacity might increase, pushing banks to embark on even more ambitious digitalization strategies. These can also be favored by the recent EC proposal to front-load the non-deduction of prudently valued software assets. Further pressure on profitability and faster digitalization might also stress the need to address overcapacity and for consolidation in the sector, at national or EU levels.
Keywords: Europe, EU, Banking, COVID-19, MREL, Credit Risk, Liquidity Risk, Basel, Regulatory Capital, Operational Risk, EBA
Previous ArticleCMF Amends Rule on Use of Surplus Mortgage Collateral in SME Loans
The European Commission (EC) published the Delegated Regulation 2021/1527 with regard to the regulatory technical standards for the contractual recognition of write down and conversion powers.
The Australian Prudential Regulation Authority (APRA) published a new set of frequently asked questions (FAQs) to provide guidance to authorized deposit-taking institutions on the interpretation of APS 120, the prudential standard on securitization.
The Single Resolution Board (SRB) published a Communication on the application of regulatory technical standard provisions on prior permission for reducing eligible liabilities instruments as of January 01, 2022.
The Australian Prudential Regulation Authority (APRA) published a new set of frequently asked questions (FAQs) to clarify the regulatory capital treatment of investments in the overseas deposit-taking and insurance subsidiaries.
The European Banking Authority (EBA) published the final report on the guidelines specifying the criteria to assess the exceptional cases when institutions exceed the large exposure limits and the time and measures needed for institutions to return to compliance.
The Prudential Regulation Authority (PRA) issued the policy statement PS20/21, which contains final rules for the application of existing consolidated prudential requirements to financial holding companies and mixed financial holding companies.
The European Banking Authority (EBA) revised the guidelines on stress tests to be conducted by the national deposit guarantee schemes under the Deposit Guarantee Schemes Directive (DGSD).
The European Commission (EC) announced that Nordea Bank has signed a guarantee agreement with the European Investment Bank (EIB) Group to support the sustainable transformation of businesses in the Nordics.
The Hong Kong Monetary Authority (HKMA) issued a circular, for all authorized institutions, to confirm its support of an information note that sets out various options available in the loan market for replacing USD LIBOR with the Secured Overnight Financing Rate (SOFR).
The Office of the Comptroller of the Currency (OCC) issued a new "Problem Bank Supervision" booklet of the Comptroller's Handbook. The booklet covers information on timely identification and rehabilitation of problem banks and their advanced supervision, enforcement, and resolution when conditions warrant.