FSI Examines Financial Stability Implications of Payment Deferrals
FSI published a brief note that examines challenges facing the banking sector as a result of the payment deferral programs put in place to support borrowers affected by the COVID-19 pandemic. The note also presents an overview of payment deferral programs and their accounting treatment, before moving on to discuss the associated practical considerations related to these payment deferrals. While analyzing the financial stability implications of implementation of these programs by the prudential regulators, FSI emphasizes the importance of timely classification and measurement of credit risk by banks.
The note highlights that prudential authorities are caught "between a rock and a hard place" as they encourage banks—through various relief measures—to provide credit to solvent, but cash-strapped borrowers, while keeping in mind the longer-term implications of these measures for the health of banks and national banking systems. In navigating these tensions, banks and supervisors face a daunting task as borrowers that may be granted payment holidays have varying risk profiles. Distinguishing between illiquid and insolvent borrowers—amid an uncertain outlook—should help guide banks' efforts to support viable borrowers, while preserving the integrity of their reported financial metrics.
IFRS 9 allows banks to recognize interest income on these missed payments, raising prospective risks if borrowers are ultimately unable to repay. In addition, if the payment moratorium is lengthy, the deferred interest payments that are added to a borrower’s loan balance and the corresponding amount that are recognized in banks’ interest income accounts will increase, accentuating medium-term risks for borrowers and banks. The extent to which these risks materialize and how they affect the accounting classification and measurement of loans, depends on two factors: first is the ability of borrowers to repay the debt once the deferral period ends and second is the availability of collateral support, including the existence of public guarantees that back the underlying exposures.
The note concludes that payment deferral programs provide an indispensable lifeline to consumers and businesses affected by COVID-19, but they could also increase future risks to the banking system. Therefore, their design will be critical in balancing the short-term needs of borrowers with longer-term financial stability considerations. The financial stability implications of payment deferral programs will be driven by the extent to which borrowers will be able and willing to repay their debt obligations once the payment holidays expire, particularly in the absence of a public guarantee. The cumulative impact of COVID-19 and payment deferral programs on bank balance sheets depends on many factors and will only become apparent over time. Therefore, the timely classification and measurement of credit risk is critical for banks to provide confidence to supervisors and their stakeholders on their financial health. Delaying loss recognition until the tide goes out may leave banks and supervisors with fewer options for dealing with the repercussions.
Keywords: International, Banking, Loan Moratorium, Loan Guarantee, Credit Risk, IFRS 9, Accounting, COVID-19, Financial Stability, FSI
Victor Calanog, Ph.D.
Leading economist; commercial real estate; performance forecasting, econometric infrastructure; data modeling; credit risk modeling; portfolio assessment; custom commercial real estate analysis; thought leader.
CECL adoption expert; engagement manager for loss estimation, internal risk capability enhancement, and counterparty credit risk management
CECL, IFRS 9, and IFRS 17 expert; credit risk and insurance risk specialist; strategic planning and credit analytics solutions consultant
Previous ArticleESMA Updates Q&A on Securitization Regulation in May 2020
BOE Sets Out Its Thinking on Regulatory Capital and Climate Risks
The Bank of England (BOE) published a working paper that aims to understand the climate-related disclosures of UK financial institutions.
OSFI Finalizes on Climate Risk Guideline, Issues Other Updates
The Office of the Superintendent of Financial Institutions (OSFI) is seeking comments, until May 31, 2023, on the draft guideline on culture and behavior risk, with final guideline expected by the end of 2023.
BIS Paper Examines Impact of Greenhouse Gas Emissions on Lending
BIS issued a paper that investigates the effect of the greenhouse gas, or GHG, emissions of firms on bank loans using bank–firm matched data of Japanese listed firms from 2006 to 2018.
HMT Mulls Alignment of Ring-Fencing and Resolution Regimes for Banks
The HM Treasury (HMT) is seeking evidence, until May 07, 2023, on practicalities of aligning the ring-fencing and the banking resolution regimes for banks.
BCBS Report Examines Impact of Basel III Framework for Banks
The Basel Committee on Banking Supervision (BCBS) published results of the Basel III monitoring exercise based on the June 30, 2022 data.
PRA Consults on Prudential Rules for "Simpler-Regime" Firms
Among the recent regulatory updates from UK authorities, a key development is the first-phase consultation, from the Prudential Regulation Authority (PRA), on simplifications to the prudential framework that would apply to the simpler-regime firms.
DNB Publishes Multiple Reporting Updates for Banks
DNB, the central bank of Netherlands, updated the list of additional reporting requests and published additional data quality checks and XBRL-Formula linkbase documents for the first quarter of 2023.
NBB Sets Out Climate Risk Expectations, Issues Reporting Updates
The National Bank of Belgium (NBB) published a communication on climate-related and environmental risks, issued an update on XBRL reporting
EBA Updates Address Securitization Standards and DGS Guidelines
The European Banking Authority (EBA) published the final draft of the regulatory technical standards that set out conditions for assessment of homogeneity of the underlying exposures in simple, transparent, and standardized (STS) securitizations.
FSB Publishes Letter to G20, Sets Out Work Priorities for 2023
The Financial Stability Board (FSB) published a letter intended for the G20 Finance Ministers and Central Bank Governors, highlighting the work that FSB will take forward under the Indian G20 Presidency in 2023