Banking turbulences in a Covid world: ECB, SRB & EBA on supervisory priorities

Crédit Agricole CIB hosted a web conference themed “Banking turbulences in a Covid world: the regulatory angle”, with delegates hearing from European Central Bank (ECB) supervisory board member Edouard Fernandez-Bollo, Delphine Reymondon, head of the liquidity, leverage, loss absorbency and capital unit at the European Banking Authority (EBA), and Sebastiano Laviola, board member and director of strategy and policy coordination at the Single Resolution Board (SRB).

(Left to right: Reymondon, Fernandez-Bollo, Laviola)

The below article is an excerpt from our extended BIHC Briefing featuring key takeaways from the web conference as well as the latest regulatory updates from Crédit Agricole CIB’s DCM Solutions team covering the EBA’s first MREL/TLAC Instruments Monitoring Report, Software & CET1 RTS, Opinion on Regulatory Treatment of Legacy Capital Instruments, and the PRA consultation on CRD V and MDA modifications – please download the full pdf here.

ECB supervisory board member Edouard Fernandez-Bollo stressed the ongoing flexibility of the European banking supervisory framework at the Crédit Agricole CIB (CACIB) web conference on 1 October, underlining that banks will not have to start rebuilding buffers before peak capital depletion is reached.

The ECB supervisory board member was speaking under the web conference theme “Banking turbulences in a Covid world: the regulatory angle”, with delegates also hearing from Delphine Reymondon, head of the liquidity, leverage, loss absorbency and capital unit at the European Banking Authority (EBA), and Sebastiano Laviola, board member and director of strategy and policy coordination at the Single Resolution Board (SRB).

As a recent example of the relief continuing to be given to banks, the ECB’s Fernandez-Bollo noted the decision, announced on 17 September, to allow the temporary exclusion of certain central bank exposures from the leverage ratio in the exceptional circumstances of the coronavirus pandemic.

“I wanted to cite this to show that we are still in the mode of using all the possibilities that are given by the framework,” he said.

The latest move comes on top of a raft of major relief measures undertaken by the ECB and other European bodies that Fernandez-Bollo discussed, such as flexibility in the treatment of non-performing loans, delays and easing in supervisory measures, and reductions in capital requirements — alongside the central bank’s recommendation that dividend payments (but not AT1 coupons) for 2019 and 2020 be ceased.

According to ECB estimates, the aggregate impact of such mitigating measures is equivalent to €120bn of CET1 capital, of which €30bn is from unpaid dividends, potentially able to finance up to €1.8tr of loans to households and corporates in need of extra liquidity. Fernandez-Bollo said this has clearly improved the resilience of the banking sector.

“Everybody is now saying that one of the really significant characteristics of this crisis is that up to now the banks have been part of the positive reaction function to the crisis,” he said. “We’ve seen in fact that the banks have not restricted lending in Europe, in particular.

“This is clearly for us due to the resilience that was built in, but also to the effect of these mitigating measures.”

Prominent among these has been the possibility for banks to fully use capital and liquidity buffers, operating below the level of capital defined by Pillar 2 Guidance (P2G) and the capital conservation buffer (CCB), and below the Liquidity Coverage Ratio (LCR).

“One of the lessons we learned from the financial crisis is that we had to be able to adjust the possibilities of banks to react to the crisis and different types of buffers were then built into the framework,” said Fernandez-Bollo.

No such flexibility was available at the time of the financial crisis, where the choice was binary: either a bank complied with capital requirements or it did not.

An ECB vulnerability analysis in July found that although a second Covid-19 wave would have no significant impact on the euro area banking system as a whole, there would be “pockets of difficulty”, and Fernandez-Bollo noted that the need for caution going forward had prompted the central bank to use “forward guidance” for the first time in respect of banking supervision, namely to allow banks to operate below P2G and the combined buffer requirement until at least end-2022, and below the LCR until at least end-2021, without automatically triggering supervisory action.

“We are very conscious that it’s not easy for a bank to use the buffers and that there’s a stigma linked to that, to being a first mover,” said Fernandez-Bollo. “We really want to destigmatise use of the buffers — to us it really makes sense to use them when you are in a transition period like this.

“That’s why it’s very important for us to use all the flexibility we have in our supervisory approach to facilitate the use of buffer.”

Given the uncertainty over the shape of the recovery, he said the end-2022 date will be subject to review, while the ECB will also monitor whether further measures will be required to encourage banks to use their buffers. There could also be an update on dividend distribution in the near future, he added.

“For the time being, what is happening is rather more benign than what we had in our stress scenario,” said Fernandez-Bollo, “but of course, we are supervisors, so we have to prepare for the worst. That’s why the word caution is still very much the order of the day in our supervisory response to the crisis.”

Cécile Bidet, head of DCM solutions and advisory at Crédit Agricole CIB, and co-host of the web conference, said that in spite of the rather good results and resilience of the banking system thus far in the crisis, the one known element at present is indeed continued uncertainty.

“In the absence of clarity, prudent banks continue to reinforce their capital basis through AT1 and Tier 2 issuances,” she said.

SRB targets intermediate MREL relief

Laviola at the SRB noted that while the resolution authority’s responsibilities mean that it is not first in line in providing relief to banks, it has acted in line with other authorities and governments.

“Our aim has been to maintain our goal of achieving the resolvability of all the banks under our remit, but at the same time being mindful not to put in place procyclical measures or to create an obstacle to the funding of the economy that was and is still needed,” he said. “Therefore, there have been a number of relief measures in terms of lengthening the deadlines for the various papers and data banks had to submit.

“We are also using the flexibility in the legislation to adapt the transition period for MREL to the actual situation on a case by case basis.”

The SRB has announced that, as regards existing BRRD1 binding targets, it will take a forward-looking approach to banks that may face difficulties in meeting those targets before new MREL decisions under the banking package take effect.

Regarding BRRD2, which comes into force at the turn of the year, the SRB is using June 2020 data to review banks’ intermediate MREL targets, which have to be hit by January 2022. This is a move away from the anticipated linear build-up of MREL.

“If there are important reasons to deviate from this linear path, then one can choose a non-linear path,” said Laviola, “and this is exactly what has been done in a number of specific cases, although not many.

“Why have we done this? Because if we are lowering the binding intermediate targets for banks that might show difficulties in fulfilling the 2022 targets, then this downward adjustment is a relief measure for the banks — notwithstanding that the target remains ambitious, because we do not deviate from the goal of achieving resolvability.”

He noted that final MREL targets are not being changed now, but are anyway due to be recalibrated each year.

Michael Benyaya, DCM solutions, Crédit Agricole CIB, noted that the SRB has provided relief to the banking system on the basis of the possibilities contained within regulations, although such relief measures may have been less visible than those of the ECB.

AT1, Tier 2 ‘play a role’

A key mitigating measure highlighted by the ECB’s Fernandez-Bollo was the frontloading of banks being able to use AT1 and Tier 2 instruments to partially meet Pillar 2 Requirements (P2R).

He further noted that although the issuance of AT1 and Tier 2 was “completely frozen” in March and April, the market has since restarted.

“So this possibility that was given to use the AT1 and the Tier 2 instruments for the Pillar 2 Requirement was indeed very useful for the banking system, allowing the banks today to build up capital for the next phase,” said Fernandez-Bollo.

“Of course, the shock to banks has been limited,” he added, “and it’s clear that AT1 and Tier 2 do not have the same loss-absorbing capacity as CET1, but for the time being I value their contributions rather positively. We will integrate all that into our forward-looking reflections about the capital framework.”

The EBA’s Reymondon was also asked about the role and relevance of AT1 and Tier 2 during the CACIB event. She said that some of the questions being raised around AT1 were perennial ones.

“They were already there many years ago even when we finalised the new capital framework back in 2011,” she said, “that AT1 instruments should not be in the landscape anymore, that you should have only CET1 and Tier 2. So it’s not a wholly new debate, but one that has indeed started again.

“From an EBA perspective, it is not appropriate to start reflecting on changes amid the crisis — we would prefer to wait. We prefer to have some stability in the regulatory framework.”

Reymondon noted that in the run-up to CRR2/CRD5 the EBA had recommended avoiding tweaks to the position of AT1 in terms of MDA-related distributions, to avoid any possibility of undermining the AT1 class. She said that similar considerations explain why the regulator is not reviewing AT1 triggers, even if it acknowledges that they are probably too low.

“This would probably also prompt a more thorough discussion on the wider capital framework,” she added, “the different buffers and layers, whether they work or not, TLAC and MREL — everything. Also, the Basel Committee has launched the evaluation exercise of the capital framework to see what is and what is not working, and we would need first to have this assessment to see if anything should be changed. This would probably take quite a lot of time.”

Doncho Donchev, DCM solutions, CACIB, noted that the top regulators remain committed to Tier 2 and, more importantly, AT1 instruments.

“However, it cannot be denied that the fear of AT1 coupon cancellation and potential funding cost fallout across the liability structure are one of the major factors inhibiting banks from buffer usage,” he added.