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    ESAs Assess Risks to Financial Sector After COVID-19 Outbreak

    September 22, 2020

    ESAs (EBA, EIOPA, and ESMA) published the first joint report that assesses risks in the financial sector since the outbreak of the COVID-19 pandemic. The report focuses on the impact of the COVID-19 pandemic on the financial sector and the Joint Committee of the ESAs advises national competent authorities, financial institutions, and market participants to take certain policy actions. The report highlights that significant challenges to the banking sector profitability present already before the pandemic have exacerbated. Additionally, the dispersion of capital levels among European banks remains high and some banks that entered the COVID-19 crisis with relatively lower capital levels and riskier exposures may face challenges.

    Valuation, liquidity, credit and solvency risks have increased across the board. While liquidity positions of EU banks remained relatively strong, the EU investment fund industry faced a significant deterioration of asset liquidity in some segments combined with substantial outflows from investors in selected asset classes. Uncertainties about the medium- and long-term economic consequences of the COVID-19 pandemic are still very high and lead to a fragile market environment going forward. The impact of the crisis on bank asset quality is expected to be a key challenge going forward. The sound capital positions of the insurance sector before the COVID-19 shock provided undertakings with certain buffers. However, the unexpected COVID-19 virus outbreak might negatively affect insurers’ solvency position. On the capital side, EIOPA encourages insurance companies to take measures to preserve their capital position in balance with the protection of the insured, following prudent dividend and other distribution policies, including variable remuneration. The report also highlights that usage of, and dependency on, information and communication technology (ICT) has further increased with the spread of the COVID-19.

    In the report, the Joint Committee of the ESAs advises national competent authorities, financial institutions, and market participants to take the following policy actions:

    • Financial institutions and supervisors should take into account various scenarios and, for example, perform stress testing or sensitivity analyses to map the impact of potential shocks.
    • Banks and supervisors should properly assess the quality of loan portfolios and consider, in their preparations, that widely introduced legislative and non-legislative loan moratoria, as well as further policy measures such as loan guarantee schemes, are of a temporary nature.
    • Financial institutions should ensure that the assessment of their capital positions is forward-looking and that it takes into account current uncertainties, following prudent dividend and other distribution policies, including variable remuneration. Additionally, supervisors and banks should make use of the flexibility embedded in the existing regulatory framework, including to use capital and liquidity buffers to absorb losses and, thus, to ensure continued lending to the economy.
    • Supervisors and financial institutions need to accommodate a further prolonged “low-for-long” interest rate environment and its risks, including addressing overcapacities in the financial sector. Notwithstanding the importance of continued lending in the crisis, banks should ensure sound lending practices and that risks are not mispriced, which should be monitored by supervisors.
    • Financial institutions and their service providers should carefully manage their ICT and security risks, including when outsourcing ICT activities. They should ensure that appropriate technologies and adequate resources are in place to address data integrity, business continuity and increasingly sophisticated cyber threats.
    • Financial institutions should also ensure to be well-prepared for any disruptions they and their clients may face at the end of the UK’s transition period agreed in the context of the UK withdrawal from the EU. Where relevant, the preparation should factor in situations in which no relevant equivalence decisions have been made by December 31, 2020.

     

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    Keywords: Europe, EU, Banking, Insurance, Securities, COVID-19, Brexit, Stress Testing, Loan Moratorium, Cyber Risk, Basel, Regulatory Capital, ESAs

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