Maintaining Banking System Safety amid the COVID-19 Crisis
IMF Blog, March 31, 2020
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- Authors: Tobias Adrian, Aditya Narain
- Published: March 31, 2020
Nature of the shock and immediate risks
- The coronavirus pandemic has caused economies to "shut down at the drop of a hat," producing rapid job and income losses for many workers and steep losses for restaurants, hotels, and airlines.
- Pressure on the banking system is growing and "higher defaults on debt are imminent."
- Many expect a shock to the financial sector "similar in magnitude to the 2008 crisis."
- Current conditions in many countries are described as "as severe as the adverse scenario of the stress tests that banking regulators commonly use to assess the strength of their banking systems."
- The text notes the possibility that "it might get worse" and that some banking systems "might have to be recapitalized or even restructured" under more severely strained circumstances.
Policy challenge for supervisors
- Bank supervisors must respond to a "fast-moving and extraordinary situation," combining tools from playbooks for natural disasters, operational risk events, and bank stress episodes.
- National authorities are taking fiscal support measures and central banks are opening new liquidity lines; supervisors must ensure "continued trust and confidence in the banking system."
- The global regulatory framework developed after the global financial crisis raised minimum standards for capital and liquidity so banks would "hold buffers above the minimum that could be safely drawn down in stressed conditions."
Supervisory prescription (IMF guidance)
- Don’t change the rules.
- "Doing this in the midst of a crisis will likely cause more confusion."
- Be prepared to give banks time to meet rules if they fall short.
- Hold off on implementing new initiatives so banks can focus on maintaining ongoing operations, especially given difficulties of operating remotely.
- Use the buffers.
- Communicate clearly that capital and liquidity buffers should support continued bank lending, "without adverse consequences for bank management."
- Note that "Banks built these buffers well above Basel minimum standards to manage strains on liquidity and revenue loss from missed loan repayments."
- Encourage loan modification.
- Supervisors should "clearly communicate to banks to be proactive in rescheduling their loan portfolio for those borrowers and sectors that have been hard hit by the severe, but temporary, shock."
- Remind banks about flexible credit risk management and the accounting standards for impairment in these situations.
- Accounting bodies have clarified to auditors "how such modifications should be viewed once the economy begins to recover."
- Don’t hide the losses.
- "Banks, investors, shareholders and even taxpayers have to bear them."
- Transparency is emphasized: "Surprises only worsen their response, as was proven during the 2008 crisis."
- Clarify regulatory treatment of support measures.
- Clarify upfront how banks and regulators should treat fiscal measures, including measures directly targeted at borrowers, credit guarantees, payment holidays, direct transfers and subsidies—beyond any current guidance in the Basel capital framework—to improve transparency.
- Strengthen communication.
- Encourage continuous dialogue between supervisors and banks, especially while working remotely.
- Typically reporting requirements in key areas (such as liquidity and creditor positions) are enhanced in a crisis; given operational disruptions, deferring other reporting requirements less material to assessments of financial health "may make sense."
- Coordinate across borders.
- Broad coordination among national regulators at the international level is "imperative."
- Preserving the integrity of the international framework is "crucial for the credibility and integrity of the global financial system."
- International bodies like the Financial Stability Board and the Basel Committee on Banking Supervision are working to support this coordination.
Scenarios and IMF role
- The outlook depends on whether economic activity can restart later in the year; if recovery is delayed or more adverse scenarios occur, "we will have to rethink our playbook substantially."
- The IMF states it "has deep experience in helping countries rebuild distressed banking systems through its technical assistance programs, and will stand ready to help."
Source: Tobias Adrian and Aditya Narain, March 31, 2020 — Maintaining Banking System Safety amid the COVID-19 Crisis