27 February 2020

Enria: Flexibility in supervision: how ECB Banking Supervision is contributing to fighting the economic fallout from the coronavirus

In this blog post, I will try to explain the rationale for the supervisory flexibility measures and distribution restriction recommendations we announced over the past two weeks in response to the economic shock from the coronavirus (COVID-19) outbreak.

From the outset our supervisors have been collecting intelligence on a continuous basis from the banks on the effects of the current severe shock. Our response to events will be reviewed and adjusted as they unfold to keep pace and ensure that banks continue performing their vital function of servicing the real economy.

We are in the midst of an unprecedented crisis generated by a totally unexpected event. The coronavirus outbreak is threatening the lives of many people around the globe and is pushing the economies of many countries into recession. We expect households, small businesses and corporates in the euro area to face extremely challenging economic and financial conditions.

Unlike in the 2008 financial crisis, banks are not the source of the problem this time. But we need to ensure that they can be part of the solution. To this end, our mitigation measures aim to allow banks to keep providing financial support to viable households, small businesses and corporates hardest hit by the current economic fallout. Likewise, our recommendation on dividend distribution restrictions is intended to keep precious capital resources within the banking system in these difficult times to enhance its capacity to lend to the real economy and to support other segments of the financial sector as they come under stress.

It is worth mentioning that our supervisory measures should not be considered in isolation. In fact, important synergies exist between what we have decided and the policies announced in parallel by monetary and fiscal authorities. The ECB, as central bank of the euro area, has provided banks with increased sources of cheap funding supplemented by an extraordinary asset purchase programme. As the banking supervisor, we have eased capital and liquidity constraints to increase the ability of banks to lend and absorb losses in this challenging environment. Euro area governments have taken noteworthy decisions to temporarily relieve the difficulties of debtors with payment moratoriums and guarantees on bank loans, and in response we have increased supervisory flexibility regarding the regulatory treatment of loans receiving such public support.

First of all, our supervisory guidance has focused on delivering a more flexible application of the unlikely-to-pay classification for borrowers that are recipients of ad-hoc governmental guarantees or for which moratoriums are enacted. In addition, loans that have government guarantees and turn non-performing will receive favourable treatment in terms of coverage requirements for a period of seven years following their deterioration.

However, prudential rules are not the end of the story. Our supervised institutions expect the current turmoil to heavily impact their capital and published financial statements through accounting outcomes. Within our remit as a prudential supervisory authority, we have asked banks to smooth the procyclicality embedded in their IFRS 9 loan loss provisioning models as much as possible. For the same reason, we recommended all institutions that have not done this so far to start applying the IFRS 9 transitional calendar available under the Capital Requirements Regulation. This will prevent the volatility in IFRS 9 valuations during the current shock having a significant impact on banks’ capital.

 

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