Annexes to COM(2020)169 - Commission communication on the application of the accounting and prudential frameworks to facilitate EU bank lending Supporting businesses and households amid COVID-19

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dossier COM(2020)169 - Commission communication on the application of the accounting and prudential frameworks to facilitate EU bank lending ...
document COM(2020)169 EN
date April 28, 2020
Annex to Commission Regulation (EU) 2016/2067 of 22 November 2016).

28      See      EBA      guidelines      on      the      application      of      the      definition      of      default,      available      at: https://eba.europa.eu/sites/default/documents/files/documents/10180/1597103/004d3356-a9dc-49d1-aab1-3591f4d42cbb/Final%20Report%20on%20Guidelines%20on%20default%20definition%20(EBA-GL-2016-07).pdf.

29  See https://eba.europa.eu/eba-provides-clarity-banks-consumers-application-prudential-framework-light-covid-19-measures; and https://www.esma.europa.eu/sites/default/files/library/esma32-63-951_statement_on_ifrs_9_implications_of_covid-19_related_support_measures.pdf

confirming the flexibility in IFRS 9 and referring explicitly to the statements of the ECB, EBA and ESMA30. The Commission concurs with the various statements from authorities that, if the support measures are temporary and related to the COVID-19 crisis, it is unlikely that the modifications will be substantial.

Use of loan guarantees and ECL provisioning under IFRS 9

Loan guarantees neither increase nor reduce the default risk of the borrower, but they reduce the amount of credit losses if a default of the borrower actually occurs. Where a government or other entity provides guarantees for bank loans to borrowers, banks need to take into account these loan guarantees when calculating the amount of expected credit loss. Consequently, the amount of expected credit losses will be lower because a part of the losses will be compensated by the guarantee.

Banks should provide insightful disclosures on the determination of expected credit losses under IFRS 9, including information on the downside scenarios. Banks should also disclose in the notes specific accounting policies adopted in relation to the COVID-19 crisis. Such disclosures allow market participants to make informed assessments on the credit risk exposures of banks.

External auditors are expected to take into account the statements issued by the BCBS, EBA31, ESMA32, the ECB33, the IASB34 and in this Communication in their audit work.

This means that they are expected to consider banks’ judgement and their use of the flexibility embedded in IFRS 9 in line with such guidance when forming their audit opinion. Further impacts of the COVID-19 crisis on statutory audit of financial statements in general are included in CEAOB’s statement35.

Transitional arrangement in the Capital Requirements Regulation

Banks are encouraged to implement the IFRS 9 transitional arrangements that will reduce the impact of IFRS 9 ECL provisioning on banks’ regulatory capital36. The Capital Requirements Regulation (CRR) contains a transitional arrangement37 that allows banks to add back to their Common Equity Tier 1 (CET1) capital any increase in provisions

30 See https://cdn.ifrs.org/-/media/feature/supporting-implementation/ifrs-9/ifrs-9-ecl-and-coronavirus.pdf?la=en

31 See EBA Statement on the application of the prudential framework regarding Default, Forbearance and IFRS9 in light of COVID-19 measures, 25 March 2020; EBA Guidelines on legislative and non-legislative moratoria on loan repayments applied in the light of the COVID-19 crisis, 2 April 2020.

32  See ESMA Statement on Accounting implications of the COVID-19 outbreak on the calculation of expected credit losses in accordance with IFRS 9, 25 March 2020.

33 See ECB Banking Supervision FAQs on ECB supervisory measures in reaction to the coronavirus, 20 March 2020; ECB Banking Supervision letter to significant institutions “IFRS 9 in the context of the coronavirus (COVID-19) pandemic”, 1 April 2020.

34  See IASB Statement on IFRS 9 and Covid-19 - Accounting for expected credit losses applying IFRS 9 Financial Instruments in the light of current uncertainty resulting from the covid-19 pandemic, 27 March 2020.

35 See CEAOB Statement emphasising areas that are of high importance in view of Covid-19 impact on audits of financial statements, 25 March 2020.

36  The ECB recommends that all banks within its prudential remit use the transitional arrangements and declared its readiness to process in a timely fashion all applications received in this context, see FAQs on ECB supervisory measures in reaction to the coronavirus, 20 March 2020.

37 Article 473a of the CRR.

due to IFRS 9 ECL accounting38. As of the second quarter of 2018, only 56% of EU banks in the EU used the transitional arrangements39. In the Euro area, only 34 banks under direct ECB supervision have used this option. Banks that opted not to use the IFRS 9 transitional arrangements in 2018 could reverse that decision subject to prior approval from their competent authority.

Competent

authorities should duly consider the current exceptional circumstances and

should process in a timely fashion applications by banks to opt for the application of the IFRS 9 transitional arrangements provided in the CRR40. To limit the possible volatility of regulatory capital that may occur if the COVID-19 crisis results in a significant increase in ECL, the BCBS has agreed on amendments to the existing transitional arrangements. These amendments would allow resetting the 5-year transition period and adjusting the calibration of the arrangements for adding back provisions to CET1 capital. The Commission is adopting today a legislative proposal to implement these amendments in Union law41.

3. Flexibility embedded in the prudential rules on the classification of non-performing

The prudential rules on the classification of non-performing loans (NPLs) can accommodate relief measures such as guarantees and private or statutory moratoria. In this regard, the EBA42 and the ECB43 have issued statements and guidance with the aim of providing clarity on how to handle in a consistent manner aspects related to (i) the classification of loans in default and (ii) the identification of forborne exposures.

Use

of guarantees and the definition of default

The prudential rules do not require a bank to automatically consider an obligor in default when it calls on a guarantee. While the CRR44 requires considering whether an obligor has become unlikely to pay without recourse to a guarantee, making recourse to a guarantee in itself does not trigger the classification as defaulted45. At the same time, a guarantee does not preclude that an obligor is classified as defaulted. Irrespective of the

38 Over a five-year period (from 1 January 2018 to 31 December 2022), the amount that banks can add back to their CET1 capital gradually decreases. The potential impact on CET1 capital can be reduced by 70% in 2020, 50% in 2021 and 25% in 2022.

39 EBA Report “First observations on the impact and implementation of IFRS 9 by EU institutions”, 20 December 2018. This number may have changed in the meantime as banks are allowed to reverse their initial decision on whether or not to apply the transitional arrangement once.

40See the EBA’s recommendation in its statement of 25 March 2020. On 20 March 2020, the ECB recommended that all banks within its prudential remit implement the transitional arrangements and declared its readiness to process in a timely fashion all applications received in this context.

41 See below 5. Monitoring and follow-up.

42 See EBA Statement on the application of the prudential framework regarding Default, Forbearance and IFRS9 in light of COVID-19 measures, 25 March 2020; EBA Guidelines on legislative and non-legislative moratoria on loan repayments applied in the light of the COVID-19 crisis, 2 April 2020.

43 See ECB Banking Supervision FAQs on ECB supervisory measures in reaction to the coronavirus, 20 March 2020; ECB Banking Supervision letter to significant institutions “IFRS 9 in the context of the coronavirus (COVID-19) pandemic”, 1 April 2020.

44 Article 178(1)(a) of the CRR.

45 See also the FAQs issued by the ECB on 20 March 2020.

loans

existence of a guarantee, the bank has to form an opinion as to whether the obligor is in a position to meet his obligations.

At this stage of the COVID-19 crisis, many borrowers face temporary problems to meet their obligations. When assessing a borrower's capabilities to meet its obligations, banks should take into account the long-term prospects of the borrower, paying attention to situations where temporary problems are most likely to transform into longer-term difficulties and eventually lead to insolvency.

Use

of payment moratoria and the definitions of forbearance and default

The public and private moratoria schemes introduced in response to the COVID-19 crisis do not automatically lead to a reclassification of an exposure as “forborne”, “performing” or “non-performing forborne”. Under the definition of forbearance46 banks typically offer specific measures (e.g. to temporarily suspend principal and/or interest payments of a loan) to help individual borrowers who are experiencing or likely to experience temporary financial difficulties with their repayment obligations. If a forbearance measure leads to a diminished financial obligation (so-called “distressed restructuring”), this indicates that the borrower is unlikely to pay its obligation47. However, the public and private moratoria schemes introduced in response to the COVID-19 crisis have a predominantly preventive and general nature. They aim to address systemic risks and alleviate potential risks that may occur in the wider EU economy in the future. They are not borrower-specific, as the length of the delays in payments is fixed for every borrower irrespective of the borrower’s specific financial circumstances48. For these reasons, they could be considered as not affecting the classification of the loans concerned. Public and private moratoria should be treated similarly to the extent they have the same purpose and similar characteristics.

The EBA guidelines of 2 April 2020 on payment moratoria49 specify under which conditions public or private payment moratoria do not trigger the classification as forbearance. Where the repayment of an obligation is suspended because of a moratorium, the counting of the ‘days past due’50 is suspended and any delays are counted based on the modified schedule of payments51. While banks are still obliged to assess the obligor’s unlikeliness to pay on a case-by-case basis, this assessment refers to the modified schedule of payments, and where there are no concerns in that regard the exposure may remain in performing status.

47 Article 178(3)(d) of the CRR.

48 See EBA Statement on the application of the prudential framework regarding Default, Forbearance and IFRS9 in light of COVID-19 measures, 25 March 2020; EBA Guidelines on legislative and non-legislative moratoria on loan repayments applied in the light of the COVID-19 crisis, 2 April 2020.

49 Guidelines on legislative and non-legislative moratoria on loan repayments applied in the light of the COVID-19 crisis, available    at:     https://eba.europa.eu/regulation-and-policy/credit-risk/guidelines-legislative-and-non-legislative-moratoria-loan-repayments-applied-light-covid-19-crisis.

50 Article 178(1)(b) of the CRR.

51 See EBA “Statement on the application of the prudential framework regarding Default, Forbearance and IFRS9 in light of COVID-19 measures”, 25 March 2020, available at: https://eba.europa.eu/eba-provides-clarity-banks-consumers-application-prudential-framework-light-covid-19-measures .

46 Article 47b of the CRR.

However, the EBA guidelines on payment moratoria clarify that banks should continue to apply in a risk-based manner their usual policies for assessing unlikeliness to pay.

Banks are expected to apply a risk-based approach to assess the credit risk of obligors benefitting from a payment moratorium. Even where payment moratoria are not classified as forbearance measures, banks have to carefully assess the credit quality of their exposures benefiting from these measures and identify any situations of unlikeness to pay of obligors for the purpose of the definition of default52. This means that banks should pay particular attention and prioritise the assessment of those obligors, who are most likely to experience payment difficulties.

4. Role

and responsibility of the banking sector

To be effective, the economic support and relief measures adopted by public authorities need effective transmission channels and the full collaboration of the banking sector. Therefore, banks need to work with each other and together with public authorities to ensure there is adequate liquidity to secure lending across the Union. Support measures by public authorities have channelled additional liquidity into the sector and released individual banks’ liquidity buffers to reinforce banks’ capacity to serve the Single Market. Banks are responsible for keeping liquidity flowing and should continue to assume their collective duty to preserve interbank lending. It is therefore crucial that banks continue to lend to households and businesses and across the Union.

Banks should accelerate the digital transformation of their businesses and remain

vigilant as regards fraud53. In the context of social distancing imposed by public authorities,

digital banking will gain ever more ground as a way to ensure continuity of banking services54.

The various supervisory measures releasing banks temporarily from certain capital, liquidity and operational requirements create better conditions for the banking sector to contribute to the collective effort and ensure, through its essential social and economic role, the transmission of public support measures. The support measures are preventive in nature aiming at addressing the immediate impact of the COVID-19 crisis and the difficulties of foreseeing the likely pace of recovery. Banks, although substantially recapitalised and much better equipped to sustain adverse scenarios than during the financial crisis of 2008/9, need nonetheless to prepare for a worsening economic outlook that will inevitably increase the risks they face and related costs. Banks have to act prudently to make sure they preserve or reinforce their capital base and implicitly their capacity to continue lending.

In the current exceptional situation, retention of dividends represents a prudent adjustment to banks’ distribution policies. Supervisors have called on banks to refrain

52 Article 178(1)(a) of the CRR.

53 See EBA statement on actions to mitigate financial crime risks in the COVID-19 pandemic, 31 March 2020.

54  See the Commission consultation on a new digital finance strategy for Europe

COVID-19 crisis55. The

from distributing dividends and making share buy-backs during the

ever-growing number of banks that have decided to suspend dividend payments is commendable and all banks in the Union are urged to refrain from making dividend distributions and carrying out share buy-backs aimed at remunerating shareholders during the period of the COVID-19 crisis. The banking sector would thus send a strong signal that it is collectively committed to play its part in dealing with the emergency.

In the current circumstances, banks are also invited to adopt a conservative approach to the payment of variable remuneration. The EBA and the Chair of the ECB’s Supervisory Board have encouraged banks to exercise moderation regarding bonuses, and a number of national supervisors have already taken some actions in this regards. In the current context, it is of paramount importance that all resources available to banks, including those allocated for bonuses are, as much as possible, mobilised to reinforce banks’ robustness, their lending capacity and so ultimately support their clients. For the banks, moderating the amount of bonuses paid out to senior management and high earners in these challenging times is also a way to express solidarity with those affected by the outbreak of COVID-19.

5. Monitoring and

follow-up

The EU has demonstrated its ability to respond to the crisis swiftly. The EBA, the ECB and national competent authorities have adopted relief measures to free banks’ operational resources and provided guidance for banks to use the full flexibility of the regulatory framework.

The Commission welcomes these measures and encourages banks to use this flexibility.

These measures were taken with the clear objective of supporting banks so they can play their role in dealing with the COVID-19 crisis. The Commission, together with the ECB, the EBA and national authorities, will monitor how banks will use the flexibility and freed-up capital and assess to what extent the relief measures contribute to the supply of bank credit. This will include monitoring of lending volumes as well as lending standards, such as banks’ underwriting criteria, to assess whether the current crisis has a tightening impact on the supply of credit.

At the same time, the Commission will continue to contribute to an internationally coordinated response at the G20, G7 and FSB level including with the international standard-setting bodies, such as the BCBS, the FSB and the IASB. Thanks to global regulatory action in the wake of the 2008/2009 financial crisis, the global banking system has significantly higher levels of capital and liquidity today compared to the beginning of that crisis. Therefore, banks are in a stronger position to absorb the shock of the global health crisis and ensure continued financing of the economy. As the pandemic is global, and as banking operations often extend beyond national borders, the regulatory response once again

55 See ECB Recommendation from 27 March 2020 on dividend distributions during the COVID-19 pandemic; and the EBA statement from 31 March 2020 on dividends distribution, share buybacks and variable remuneration. National competent authorities have equally issued similar statements.

needs to be coordinated at the global level. In this respect, the G20 has issued at its Ministerial meeting of 15 April an Action Plan providing a broad response to the COVID-19 crisis and its economic consequences, including actions in the sphere of financial regulation and supervision. The Commission’s work at the global level includes (i) sharing information on measures that the EU is taking, (ii) contributing to the global policy response and (iii) facilitating the implementation of globally agreed measures in the EU. The Commission welcomes the decisions by the BCBS of 27 March56 and 3 April57, respectively, to delay the implementation of the final elements of the Basel III reform by one year, and to extend the transitional arrangements for the regulatory capital treatment of ECL accounting. The Commission furthermore welcomes the FSB’s announcement of 2 April58 to re-prioritise its work programme to maximise the value of its work for the COVID-19 response. The Commission plans to postpone the adoption of its legislative proposal on the final elements of the Basel III framework, but to still adopt in time for the outstanding Basel III standards to be effectively implemented in the EU by January 2023. The Commission will take into account the impact of the COVID-19 crisis on banks’ financial situation in the impact assessment that will accompany that proposal.

Regulatory and supervisory actions have demonstrated that ample flexibility exists to promote continued lending to clients affected by the COVID-19 crisis within the limits of the Union’s regulatory framework. Broad changes are not advisable in this situation and they would rather increase banks’ operational burden as banks would need to adjust to them. Moreover, sudden changes to the EU’s accounting and prudential frameworks in the midst of a crisis could erode the public’s trust in EU banks.

At the same time, targeted changes to specific aspects of the prudential framework are necessary to enable banks to play their critical role in supporting people and the economy. Therefore, the Commission is adopting, together with this Interpretative Communication a legislative proposal59 to implement the amendments to the existing transitional arrangements for ECL accounting and the deferral of the new leverage ratio buffer requirement put forward by the BCBS as well as some limited changes to specific elements of the CRR to maximise banks’ capacity to absorb losses related to the COVID-19 outbreak and to continue lending to businesses and households, while still ensuring their continued resilience.

Measures to help consumers may also need to be reinforced, because the decline in households’ disposable income linked to job losses or decreased economic activity is likely to increase over-indebtedness in the EU. These issues will be considered in the review of the Consumer Credit Directive (2008/48/EC) and the Mortgage Credit Directive (2014/17/EU), foreseen in 2021.

56 See https://www.bis.org/press/p200327.htm

57 See https://www.bis.org/press/p200403.htm.

58 See https://www.fsb.org/work-of-the-fsb/addressing-financial-stability-risks-of-covid-19/

59  Proposal for a Regulation of the European Parliament and of the Council amending Regulations (EU) No 575/2013 (EU) 2019/876 as regards adjustments in response to the COVID-19 pandemic, COM(2020)310 of 28.04.2020.

and

Going forward, the Commission will further engage with the European financial sector on its role in the fight against the coronavirus and its socio-economic impacts, and the support of a sustainable economic recovery. The response must be a European one, avoiding national fragmentation and uncoordinated action.

For this purpose, the Commission will launch a dialogue with the European financial sector and other relevant stakeholders (businesses and consumers representatives) to explore ideas on how the sector should participate in efforts to support citizens and businesses through the crisis period and during the subsequent recovery, based on best practices and, going forward, facilitate a sustainable economic recovery based on the green and digital transitions in the context of the forthcoming renewed EU sustainable finance strategy. To this end, the Commission will work closely with all relevant stakeholders in the financial sector to support their role and engagement in supporting European businesses and households.