06 August 2020

BIS Prudential response to debt under Covid-19: the supervisory challenges

• In response to the Covid-19 pandemic, governments and banks have introduced public guarantees and payment deferrals to support struggling borrowers, while the Basel Committee on Banking Supervision (BCBS) and national authorities have provided guidance on how these relief measures should be considered in assessing credit risk in prudential frameworks.
• The regulatory relief measures introduced by the BCBS provide banks with flexibility in supporting the real economy. But they also raise supervisory challenges that become more pronounced the longer the relief measures remain in place, particularly if credit risks continue to mount on bank balance sheets.
• The greatest challenge for all prudential authorities is to decide how and when to exit from these regulatory relief measures. Acting too early may remove much needed credit to support economic growth, while waiting too long could undermine confidence in the post-crisis regulatory regime and heighten systemic risks. Making the right calls at the right time will require judgment.

The Covid-19 pandemic has led to catastrophic job losses that threaten to trigger loan defaults and
bankruptcies, with severe consequences for society and financial systems. Banks are in the eye of the
unfolding economic storm, given their role in providing credit to the real economy, while ensuring that
they maintain sufficient capital to absorb future loan losses.

To alleviate strains in the financial system and the economy, jurisdictions have introduced credit
guarantees and payment deferral programmes to support bank lending to businesses and households.
Meanwhile, the BCBS and prudential authorities have unveiled extraordinary regulatory relief measures.
Some of these prescribe how banks and their supervisors should consider debt relief programmes within
the prudential framework. While these initiatives provide banks with sufficient scope to support the
economy, they also raise supervisory challenges. Given their “safety and soundness” mandate, prudential
authorities – through the supervisory review process – also need to determine how the various regulatory
relief measures may affect banks’ asset quality and regulatory capital metrics, which in turn drive
supervisory risk assessments and follow-up actions.

This brief examines the credit risk-related regulatory relief measures introduced by the BCBS and
prudential authorities and outlines their supervisory implications. Section 2 summarises key features of the
public guarantees and payment deferral schemes. Section 3 specifies how Covid-19-affected borrowers
granted debt relief are classified under the BCBS’s prudential guidelines on problem assets; and how such
exposures and the related expected credit loss (ECL) provisions are considered in calculating regulatory
capital. Section 4 outlines the supervisory challenges arising from these relief measures, while Section 5
concludes.

Full paper

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