By Dr. Ranee Jayamaha
Covid-19 virus has pushed the world into a recession with huge health risk for human beings. Never before have modern economies shut down or locked down at short notice. China was the first country to experience the full force of Covid-19 and today, the confirmed affected cases across the world is over 1,780,315 with nearly 108,828 deaths. The economic consequences of the pandemic are already impacting USA and Europe with unprecedented speed and severity while, the virus has started to ripple through emerging and developing markets requiring new strategies to safeguard their productive sectors as well as banking and financial services.
Naturally, pressure on the banking and financial services is growing and higher debt defaults are imminent. Although many seem to compare the shock to the financial sector similar in magnitude to the 2008/09 world financial crisis, the background to the two crises are fundamentally different. The 2008 financial crisis started off from a regulatory vacuum following the relaxed regulatory framework adopted by USA and Europe which enabled banks to maintain capital adequacy on the basis of their internal rating systems. In the post 2008/09 period, globally, banks were forced to build up capital cushions for any emergencies under Basle II and III capital adequacy frameworks. Therefore, in terms of regulatory background and capital strengths of banks, there is a significant difference between pre 2008 period and the breakthrough of Covid-19 in Q1 of 2020.
Global central banks have now flagged that banks should dip into capital and liquidity buffers, which are generally much higher than what they had prior to 2008 financial crisis and that many would be able to withstand the pressures of Covid-19 with the help of their national regulators. The issue is whether such capital cushions would be enough to deal with the severe impacts of Covid-19 especially as delayed payments by households and businesses should command higher provisions. Banks may be able to hold on for a while but it depends on the duration of lock down/shutdown of countries and the time taken by respective governments to contain the virus from spreading. Governments and national regulators in many jurisdictions have introduced extraordinary support measures to alleviate the financial and economic impact of Covid-19, including a range of government guarantee programs for bank loans and debt payment moratoria. These measures are aimed at ensuring that banks are safe, they can continue to lend to households and businesses and to mitigate the adverse impacts of Covid-19 on the economy.
This note intends to outline the various regulatory measures introduced by selected central banks and regulatory authorities to facilitate banks to ride over the Covid-19 crisis while maintaining stability of the national and global financial systems.
The Central Bank of Sri Lanka (CBSL):
As a part of its monetary policy package, to stimulate growth and provide support to SMEs, the Monetary Board (MB) of the CBSL reduced its policy rate on 30 Jan 2020 by 50 bp to 6.50% on Standing Deposit Facility Rate (SDFR) and to 7.50% on Standing Lending Facility Rate (SLFR). Given the urgent need to support economic activity with the rapid global spread of the COVID-19 pandemic and its possible spread in Sri Lanka, on 16 March 2020, MB further reduced SDFR and SLFR by 25 BP to 6.25 per cent and 7.25 per cent, respectively. With effect from 17 March 2020, the Statutory Reserve Ratio (SRR) on all rupee deposit liabilities of commercial banks was also reduced by 1.00 percentage point to 4.00 per cent. These decisions were aimed at releasing adequate liquidity to the economy. In addition, CBSL has introduced several extraordinary regulatory measures to provide flexibility to commercial and specialized banks to provide relief to businesses and individuals affected by the COVID-19 crisis. CBSL considered the overall resilience of the banking sector especially in the light of the built-up capital buffers, the current and future liquidity levels, potential upsurge in the rising trend in non-performing loans (NPLs) and extraordinary disruptions to the functioning of the economy and announced the following regulatory measures:
- Allow Domestic Systemically Important banks (D-SIBs) and non-D-SIBs to draw-down their Capital Conservation Buffers (CCB) by 100 bps and 50 bps, respectively, to facilitate smooth credit flows to the economy and COVID-19 affected borrowers to sustain their businesses in the immediate future.
- Withdraw the requirement to classify all credit facilities extended to a borrower as non-performing when the aggregate amount of all outstanding NPLs granted to such borrower exceed 30% of total credit facilities.
- Allow banks to recover loans in Rupees, as the last resort, circumstances where recovery of loans in foreign currency is remote, subject to banks ensuring certain conditions are met.
- Permit banks to give an extension of 60 days, to borrowers who are not entitled to any other concessions, to settle loans and advances which are becoming past due during March 2020 and not to consider such facilities as past due until the end of this 60-day period.
- Allow banks to consider all changes made to payment terms and loan contracts from 16.03.2020 to 30.06.2020, due to challenges faced by customers amidst the COVID-19 outbreak as ‘modifications’ instead of ‘restructuring’ for the purpose of classification of loans & advances and computing impairment.
- Defer the requirement to enhance capital by banks which are yet to meet the requirement by end 2020, till end 2022.
- Reset the timelines for addressing supervisory concerns, if necessary, by prioritizing on the severity and importance of the concerns raised. Banks which are required to meet time lines to address supervisory concerns/findings during the period up to 30 May 2020, are granted a further period of 3 months for addressing such supervisory concerns.
- Extend the deadline for submission of statutory returns to the Bank Supervision Department by two weeks and the publication of quarterly financial statements by one month, until further notice.
- Banks to avail of these relaxations in the best interest of supporting their customers and the economy at large, the benefits of which would, in return, accrue to the banking sector to remain resilient.
The Bank of England and Prudential Regulatory Authority in the UK:
In addition to a series of measures under monetary easing, on 11 March 2020, the Bank of England (the “BoE”) announced a package of prudential measures designed to help UK businesses and households “bridge” the economic disruption caused by the Covid-19 outbreak. These measures, which are intended to help banks and building societies maintain the flow of credit into the wider economy, include: (i) a new Term Funding scheme with additional incentives for Small and Medium-sized Enterprises (“TFSME”); and (ii) a reduction in the UK countercyclical buffer to 0% and (iii) confirmation of supervisory guidance that capital and liquidity buffers can be used to address temporary shocks. The March 2020 measures announced by the BoE included:
- Countercyclical buffer reduced to 0%: The Financial Policy Committee (“FPC”) reduced the UK countercyclical capital buffer (CCB) rate to 0% of banks’ exposures to UK borrowers with immediate effect for at least 12 months. The rate had been 1% and was due to reach 2% by December 2020 to deal with transitional risks from Brexit. According to the BoE, the release of the CCB will support up to £190 billion of bank lending to businesses. Any subsequent increase will not take effect until March 2022 at the earliest.
- Regulatory Guidance: The FPC and the Prudential Regulation Committee (“PRC”) specifically noted that all elements of bank capital and liquidity buffers can be drawn down as necessary to support the economy through a temporary shock like Covid-19. Prudential Regulatory Authority (PRA) re-iterated that the role of capital buffers is to absorb losses in times of stress such as the current conditions. It emphasized that (i) the use of the PRA Pillar 2 buffer or the capital requirements directive (CRD IV) combined buffer is not a breach of capital requirements or the Threshold Conditions, (ii) the PRA buffer is confidential and the automatic distribution restrictions which apply to the CRD IV combined buffer do not apply to it and (iii) automatic restrictions resulting from use of the CRD IV combined buffer are a capital conservation measure.
In addition, the UK regulators expect banks to take a sensible approach to current market conditions. For example, the PRA also announced its supervisory expectation that banks should not increase dividends or other distributions, such as bonuses, in response to these policy actions being taken. Finally, in response to the material fall in government bond yields in recent weeks, the PRC invites requests from insurance companies to use the flexibility in Solvency II regulations to recalculate the transitional measures that smooth the impact of market movements.
The European Banking Authority (the “EBA”), the European Central Bank (the “ECB”) and National Competent Authorities (“NCAs”):
These three institutions are coordinating efforts to alleviate the immediate market stress for banks from the Covid-19, including measures such as relaxing inspections and reporting dates and forbearance of meeting capital buffers with non- common equity tier I (CET1) capital.
The EBA has decided to:
- postpone the EU-wide stress test exercise to 2021, and allow banks to focus on the continuity of their core operations and ongoing support for their customers;
- recommend NCAs to plan supervisory activities, including on-site inspections, in a flexible way and postpone those deemed non-essential; and NCAs to give banks some leeway in the remittance dates for some areas of supervisory reporting;
- encourage NCAs, where appropriate, to make full use of flexibility already embedded in the regulatory framework (e.g. similar to the ECB’s decision to allow significant banks to cover Pillar 2 requirements with capital instruments other than CET1;
- note that the liquidity coverage ratio is designed to be used by banks under stress and NCAs should avoid any measures that may lead to the fragmentation of funding markets;
- call for a dialogue between supervisors and banks on their non-performing exposures (NPEs) on a case by case basis.
- The ECBannounced a number of measures to ensure that directly supervised banks under the Single Supervisory Mechanism can continue to fulfil their role in funding the real economy despite the economic effects of Covid-19. Accordingly, ECB:
- allows banks to operate temporarily below the level of capital defined by the Pillar 2 Guidance (P2G), the capital conservation buffer (CCB) and the liquidity coverage ratio (LCR). ECB considers that these temporary measures will be enhanced by the appropriate relaxation of the countercyclical capital buffer (CCyB) by the national macroprudential authorities;
- allows banks to use capital instruments that do not qualify as CET1 capital, for example Additional Tier 1 or Tier 2 instruments, to meet the part of the Pillar 2 Requirements (P2R). This brings forward a measure that was initially scheduled to come into effect in January 2021, as part of capital requirements directive-IV (CRD IV):
- will discuss with banks individual measures, such as adjusting timetables, processes and deadlines. For example, the ECB will take a more flexible and pragmatic approach to onsite inspections and will consider extending deadlines for certain non-critical supervisory measures and data requests. ECB makes remarks similar to the EBA in relation to NPEs and sufficient flexibility to supervisors to adjust to bank-specific circumstances;
- requests banks to review their business continuity plans (BCPs) and consider what actions could be taken to enhance preparedness to minimize the potential adverse effects of the spread of Covid-19.
The Federal Reserve Bank (The Fed)
- direct lending to banks:The Fed lowered the Federal funds rate (FFR) that it charges banks for loans from its discount window by 1.5 percentage points, from 1.75 percent to 0.25 percent, lower than during the Great Recession (2008/09). These loans are typically overnight, but the Fed has extended their terms to 90 days. Banks pledge a wide variety of collateral (securities, loans, etc.) to the Fed in exchange for cash (collateralized) and the cash allows banks to keep functioning; depositors can continue to withdraw money; and the banks can make new loans.
- Temporarily relaxing regulatory requirements:The Fed is encouraging banks to dip into their regulatory capital and liquidity buffers, so they can increase lending during the downturn. The reforms instituted after the financial crisis require banks to hold additional loss-absorbing capital to prevent future bailouts. But these capital buffers can be used during a downturn to stimulate lending, and the Fed is encouraging that now, including through a technical change to its TLAC (total loss-absorbing capacity) requirement, which includes capital and long-term debt. To preserve capital, big banks also are suspending their share buybacks.
- In many other countries, most of the credit flows through the banks. In the U.S, a lot of flows through the capital markets, so the Fed is trying to keep them functioning as smoothly as possible. When financial markets are clogged, firms tend to draw on bank lines of credit, and that can lead banks to sell Treasury and other securities or pull back on other loans. The Fed is supplying unlimited liquidity to the banks, so they can meet credit drawdowns and relieve any balance sheet strain.
International Standard setters: Basel Committee on Bank supervision (the Committee)
The Committee sets out additional measures to alleviate the impact of Covid-19 on the global banking system. These measures support the provision of lending by banks to the real economy and provide additional operational capacity for banks and supervisors to respond to the immediate needs:
Expected credit loss accounting: The Committee reiterates the importance of expected credit loss (ECL) accounting frameworks as a forward-looking measure of credit losses, and expects banks to continue to apply the relevant frameworks for accounting purposes. Banks should use the flexibility inherent in these frameworks to take account of the mitigating effect of the extraordinary support measures related to Covid-19. In addition, the Committee has agreed to amend its transitional arrangements for the regulatory capital treatment of ECL accounting. The adjustments will provide jurisdictions with greater flexibility in deciding whether and how to phase in the impact of expected credit losses on regulatory capital.
Margin requirements for non-centrally cleared derivatives: The Committee and the International Organization of Securities Commissions (IOSCO) have agreed to defer the final two implementation phases of the framework for margin requirements for non-centrally cleared derivatives by one year.
Global systemically important banks (GSIBs) annual assessment: The Committee will conduct the 2020 G-SIBs assessment exercise as planned, based on end-2019 data, but has agreed not to collect the memorandum data included in the data collection template. It has also decided to postpone the implementation of the revised G-SIB framework by one year, from 2021 to 2022. These adjustments will provide additional operational capacity for banks and supervisors in the current juncture. Banks and supervisors must remain vigilant in light of the rapidly evolving nature of Covid-19 to ensure that the global banking system remains financially and operationally resilient. The Committee also reiterates its view that capital resources should be used by banks to support the real economy and absorb losses.
Financial Action Task Force (FATF):
COVID-19 and measures to combat illicit financing
The members of the FATF, both domestically and multilaterally, are applying every available resource to combat the COVID-19 pandemic. As the global standard‑setter for combating money laundering (ML) and the financing of terrorism (TF) and proliferation, the FATF encourages governments to work with financial institutions and other businesses to use the flexibility built into the FATF’s risk-based approach to address the challenges posed by COVID-19 whilst remaining alert to new and emerging illicit finance risks .
Sri Lanka Compares Well with Other Central Banks and Regulatory Authorities
The Sri Lankan economy began to pick up following the Easter Sunday terrorist attack and now the Covid-19 pandemic is likely to adversely affect some of the main productive sectors as well as service industries like tourism. Due to fast decision making on all fronts and dedication at all levels, Sri Lanka is managing with a relatively a fewer number of deaths so far. On the regulatory front, today’s global financial system is far more resilient and with appropriate regulatory forbearance it will ride through the impacts of Covid-19. Sri Lanka’s banking sector, as a whole, has complied with national and international regulatory norms and was stable as at the end of 2019 although some of the non-bank financial institutions have been experiencing difficulties in meeting regulatory requirements and repayment of deposit liabilities. Such companies too were provided with liquidity support through relaxation of monetary policy and regulatory forbearance. Sri Lanka’s current legal and regulatory framework is adequate to deal with disasters of this nature and the regulatory authorities have taken necessary measures in line with other regulatory agencies and international standard setters. This situation may have to be regularly reviewed taking into account the degree of containment of the virus and the urgency of getting the economy back on track.
 Worldormeter website as of 11th April 2020
 Monday, March 30, 2020
 On 12 March 2020 and consistent with the EBA’s views
 Press release, 03 April 2020
 Paris, 1 April 2020