FAQs on ECB supervisory measures in reaction to the coronavirus
To be updated depending on developments. Last updated 23 July 2021.
You announced flexibility when implementing the ECB Guidance on non-performing loans (NPLs). Are you considering forbearance for NPLs? Are you looking at other ways to mitigate the deterioration of asset quality, for example with regard to IFRS9?
The ECB Guidance on NPLs already embeds flexibility and case-by-case assessments by Joint Supervisory Teams (JSTs).
In exercising flexibility, the right balance should be achieved between helping banks absorb the impact of the current downturn, on the one hand, and maintaining the correct risk identification practices and risk management incentives, on the other, as well as ensuring that only sustainable solutions for viable distressed debtors are deployed.
It remains crucial, in times of distress, to continue identifying and reporting asset quality deterioration and the build-up of NPLs in accordance with the existing rules, so as to maintain a clear and accurate picture of risks in the banking sector. At the same time flexibility should be deployed to help banks absorb the impact of credit risk developments and mitigate the procyclicality of that impact.
Against the backdrop of these guiding principles, and to complement the case-by-case flexibility embedded in the ECB Guidance on NPLs and in the Addendum, the ECB has taken the additional actions described below.
In relation to all exposures that benefit from government guarantees issued by Member States in the context of public interventions relating to the coronavirus (COVID-19) pandemic, the ECB, within its own remit, and within the context of the ECB Guidance on NPLs and the Addendum, has extended flexibility on the automatic classification of obligors as unlikely to pay when institutions call on the coronavirus-related public guarantees, as allowed under the Guidelines on the application of the definition of default issued by the European Banking Authority.
The preferential treatment foreseen for NPLs guaranteed or insured by Official Export Credit Agencies is extended to non-performing exposures that benefit from guarantees granted by national governments or other public entities. This ensures alignment with the treatment provided in Regulation (EU) 2020/873 (the CRR “quick fix”). Concretely, this means that banks would face a 0% minimum coverage expectation for the first seven years of the NPE vintage count.
The ECB also extends flexibility to the NPL classification of exposures covered by qualifying legislative and non-legislative moratoria, following the EBA guidelines on legislative and non-legislative moratoria on loan repayments applied in the light of the coronavirus crisis, as amended. More precisely, the ECB complies with the abovementioned EBA guidelines. Paragraph 17(bis) of these guidelines require significant banks to notify the ECB of how they assess creditors’ creditworthiness in the context of moratoria; the ECB expects banks to do this when responding to the letter of 4 December 2020 on “Identification and measurement of credit risk in the context of the coronavirus (COVID-19) pandemic”.
Accounting standards, and their implementation, do not fall within the remit of ECB Banking Supervision, which can take very limited action in this regard. In a letter to banks under its supervision dated 1 April 2020, the ECB provided guidance to mitigate volatility in banks’ regulatory capital and financial statements stemming from IFRS 9 accounting practices, including on the use of forecasts to avoid excessively procyclical assumptions in expected credit loss (ECL) estimations. Given that the IFRS 9 provisions must be based on macroeconomic forecasts and that, particularly in times of pronounced uncertainty, IFRS 9 model outcomes may be excessively variable and procyclical, the ECB:
- Encourages those banks under its supervision that have not already done so to fully implement the transitional IFRS 9 arrangements foreseen in Article 473(a) of the CRR. The ECB stands ready to process in a timely fashion all applications received in this context.
- Expects banks to consider whether a top-down collective approach can be applied to estimate a portion of the portfolio for which credit risk has increased significantly. This is especially important in times where information at loan level is not yet available to banks.
- Expects that, within the framework provided by international accounting standards, banks give a greater weight to long-term macroeconomic forecasts evidenced by historical information when estimating long-term expected credit losses for the purposes of IFRS 9 provisioning policies. This appears particularly important where banks face uncertainty in generating reasonable and supportable forecasts. In producing such forecasts banks should take into account the relief measures granted by public authorities – such as payment moratoriums.
- Expects that banks consider ECB publications on macroeconomic projections in applying IFRS 9 provisioning policies.
Adopting transitional IFRS 9 implementation measures should allow all banks to filter out from their prudential capital a large part of the additional IFRS 9 volatility from 2020 until the end of the planned transitional period. The measures proposed under (2), (3) and (4) should also help mitigate procyclicality in banks’ published financial statements.
The ECB welcomes the extension of IFRS 9 transitional arrangements introduced by Regulation (EU) 2020/873 (the CRR “quick fix”). This legislation extends the IFRS 9 transitional arrangements by two years, and institutions are allowed to fully add back to their Common Equity Tier 1 capital any increase in expected credit loss provisions that they recognise in 2020 and 2021 for their financial assets that are not credit-impaired, as compared to end-2019. In addition, a temporary prudential filter that neutralises the impact of the volatility in central government debt markets on institutions’ regulatory capital during the coronavirus pandemic has been introduced.
Will you also revise your expectations for the stock of NPLs?
In the context of the financial turmoil triggered by the coronavirus outbreak, banks should be supported as they provide solutions to viable distressed customers. The stock of NPLs accumulated prior to the outbreak is not the focus of our current mitigation measures. However, the ECB is fully aware that current market conditions may make the agreed reduction targets difficult to attain and somewhat unrealistic. In this vein, the JSTs will be fully flexible when discussing the implementation of NPL strategies on a case-by-case basis.
Regarding the submission of updated NPL strategies, the ECB announced on 28 July 2020 its decision to postpone the deadline for submission by another six months, to end-March 2021, to provide banks with additional time to better estimate the impact of the coronavirus pandemic on asset quality, which should enable more accurate planning.
Banks are nonetheless still expected to continue with the active management of their NPLs and any foreclosed assets.
Did you provide guidance regarding the operational management of asset quality deterioration during this time?
In order to be able to provide support to viable distressed borrowers, banks need to ensure that they have effective risk management practices and sufficient operational capacity in place. Therefore, in a letter dated 28 July 2020 to all banks under its direct supervision, the ECB provided a number of high level supervisory expectations along with more specific operational elements, which banks are expected to follow. As a follow-up to this letter, JSTs have been engaging with banks to discuss their risk management practices in the light of these expectations, focusing on any gaps identified.
How does the letter “Identification and measurement of credit risk in the context of the coronavirus (COVID-19) pandemic”, published on 4 December 2020, relate to previous communications from the ECB?
The purpose of the letter to banks of 4 December 2020 is to provide banks with additional guidance on credit risk identification and measurement in the context of the COVID-19 pandemic. Indeed, as the pandemic has progressed, the ECB’s supervisory activities have identified heterogeneous practices across significant banks with regard to the implementation of the letter of 1 April 2020. The letter published on 4 December 2020 therefore serves to further clarify what the ECB considers to be sound risk management policies and procedures. Further background is available in this blog post.
The letter published on 28 July 2020 complements the above communication and sets supervisory expectations with respect to operational preparedness to deal with distressed debtors.
You announced in March 2020 that JSTs would discuss with individual banks a more flexible approach to supervisory processes, timelines and deadlines. Do you foresee any further postponements?
To alleviate the supervisory burden for banks during stressed times, the ECB clarified on 20 March 2020 that it had decided to do the following.
- Postpone, by six months, the existing deadline for remedial actions imposed in the context of on-site inspections, TRIM investigations and internal model investigations.
- Postpone, by six months, the verification of compliance with qualitative SREP measures.
- Postpone, by six months, the issuance of TRIM decisions, on-site follow up letters and internal model decisions not yet communicated to institutions, unless the bank explicitly asks for a decision because it is seen as beneficial to the bank.
- Permit banks with stable recovery plans to submit only the core elements (indicators, options, overall recovery capacity) of their 2020 plans, focusing on the current coronavirus stress and ensuring that the plans can be implemented effectively and in a timely manner if needed. Banks were also permitted, where applicable, to address only the key deficiencies identified in the 2019 plans.
In addition to the above, in 2020 the ECB did not undertake comprehensive information gathering relating to the LCR for the products and services referred to under Article 23 of the LCR Delegated Regulation for which the likelihood and potential volume of liquidity outflows are material. However, banks are reminded that they are still required to properly estimate outflow rates for these products and services based on their own methodologies, unless otherwise determined by the ECB in the past, and that such estimates should reflect the assumption of combined idiosyncratic and market-wide stress as referred to in Article 5 of the LCR Delegated Regulation. In that regard, these estimates should also reflect experiences made during the current stress period.
Taking into account the economic and financial developments so far and the gradual return to normality at most banks, the ECB does not foresee any further postponements of the deadlines for remedial actions imposed in ECB decisions and operational acts including in relation to on-site inspections, TRIM investigations and internal model investigations. Similarly, it resumed the supervisory processes for adopting new decisions on TRIM, on-site follow up letters and internal model decisions from October 2020.
The measures taken regarding recovery plans do not apply to deadlines, meaning that banks still had to submit their 2020 recovery plans by the existing deadlines.
In March 2020, you postponed the verification of compliance with qualitative SREP measures by six months. Was there any further postponement?
No. Instead, the ECB decided to resume the process of verifying compliance with qualitative SREP measures. Considering the pragmatic approach to the SREP mentioned in the Supervision Blog published in May 2020 and taking into account the requirements currently applicable to the banks, the ECB decided as a general rule to not issue SREP decisions for the 2020 SREP cycle. Nevertheless, based on the assessment conducted in 2020, unless justified by exceptional circumstances affecting individual banks, observations and concerns were conveyed to banks as qualitative recommendations upon conclusion of the SREP.
The ECB will continue to monitor the evolution of the situation and take a flexible approach when considering any need to revise its stance.
You have allowed banks to operate below the P2G level and to frontload the rules on the composition of P2R originally scheduled to come into force in 2021 with CRD V. Concretely, how much capital relief has this provided?
We have announced in the press release of 20 March 2020 that a release of the full Pillar 2 Guidance (P2G) buffer would make around €90 billion of Common Equity Tier 1 (CET1) capital available to banks under direct ECB supervision. With the immediate implementation of the latest Capital Requirements Directive (CRD V) rules on the composition of Pillar 2 Requirements (P2R), which are less stringent than the composition currently requested by the ECB, around €30 billion of additional CET1 capital have been added to the relief. The two measures combined have provided banks with aggregate relief of roughly €120 billion of CET1 capital. Overall, this has provided significant room for banks to absorb losses on outstanding exposures without triggering any supervisory action.
As announced in the press release of 20 March, the ECB estimates that the capital released by the two measures could enable banks to potentially finance up to €1.8 trillion of loans to households, small businesses and corporate customers in need of extra liquidity, taking into account that the average risk of lending to households, small businesses and corporates would most likely increase from current levels as a result of the shock. Thus, even in the most adverse scenarios, the lending capacity released by the measures remains very substantial.
These estimates do not take into account the beneficial effects of the public guarantees provided by various Member States in favour of household and/or corporate borrowers. As public guarantees substantially reduce the regulatory capital cost of lending and the amount of provisions that banks need to take against expected losses, such public measures increase the lending potential of banks.
Since March 2020 banks have issued more Additional Tier 1 and Tier 2 instruments, thereby increasing the CET1 capital relief stemming from the change in P2R composition from €30 billion of CET1 capital initially to €42 billion of CET1 capital as at 30 September 2020. On that date, the capital relief reached approximately €200 billion of CET1 capital, taking into account the aforementioned €42 billion, P2G relief of about €90 billion, macroprudential buffers relief of about €20 billion, €28 billion of dividends withheld in 2020 and €25 billion of provisions added back to CET1 capital under the IFRS 9 transitional arrangements.
How does allowing banks to operate below the P2G help the economy in the current situation?
P2G is a supervisory expectation about the bank’s ability to maintain an adequate level of capital to be able to withstand stressed conditions. It should be built up in normal times in order to make banks’ capital positions stronger in the event of a crisis. Allowing banks to operate below the level of capital defined by the P2G makes additional resources available to banks that should be used to provide more financial support to household and corporate borrowers and/or to withstand additional losses on existing exposures to those borrowers.
You said banks can fully use their capital buffers, including the capital conservation buffer (CCB). Does this mean you expect banks’ capital losses to reach levels that will deplete the CCB buffer? What are the implications if that happens?
The ECB’s indication that banks can also use the CCB buffer is not linked to a specific expectation regarding capital losses. The ECB reminds banks under its supervision that, in these difficult times, all capital buffers including the CCB may be used to withstand potential stress, in line with the initial intentions of the international standard setter on the usability of the buffers [Newsletter on buffer usability, 31 October 2019]. Having said that, as indicated in the notes to the press release of 12 March 2020, in the case of banks’ capital falling below the combined buffer requirement (CCB, CCyB and systemic buffers), banks can make distributions only within the limits of the maximum distributable amount (MDA) as defined by EU law.
The ECB does not have any discretion to waive the application of automatic restrictions to distributions that are set out in the EU law. However, the ECB decision to frontload the CRD V rules on the composition of P2R reduces the MDA trigger level for banks with enough AT1/T2 capital.
This said, the ECB will continue to take a flexible approach to approving capital conservation plans that banks are legally required to submit if they breach the combined buffer requirement.
You allowed banks to go below the liquidity coverage ratio (LCR) requirement. What does this imply?
Banks have made important efforts in recent years to achieve good levels of liquidity buffers (evidenced by the LCRs being well above the 100% minimum). The ECB clarified in the press release of 12 March 2020 that these buffers can be used to a substantial extent. This is indeed one of the foundations of the LCR, fully recognised by the international standards setter and reflected in EU regulation. It is key that banks make use of their liquidity buffers under stress, even if that means that their LCR falls substantially below the general 100% minimum level. This is important to ensure liquidity in the system and to avoid contagion effects that might trigger liquidity problems in other institutions, and, ultimately, the real economy.
By emphasising that banks can make use of their liquidity buffers to cover net liquidity outflows, the ECB effectively confirmed – ex ante – that the current environment corresponds to a situation in which the applicable regulation explicitly allows banks to use their liquidity buffers.
The ECB will continue to take a flexible approach when approving LCR restoration plans which banks are legally required to submit when breaching the LCR requirement.
You allowed banks to temporarily operate below P2G and the LCR requirement. When are banks expected to replenish them?
The ECB announced in the press release of 12 March 2020 that banks are allowed to operate below P2G and LCR requirements until further notice.
By drawing down their capital buffers, banks can retain their ability to continue lending to households and businesses through the current period of stress. Other things remaining equal, maintaining support for the real economy will also reduce the level of credit losses affecting the banking system, thereby helping to mitigate the downward pressure on banks’ solvency ratios.
The ECB will cautiously take into account the evolution of economic conditions and the credit cycle before requesting that banks replenish their Pillar 2 Guidance. This will not happen too early in the capital cycle. The timeline for P2G replenishment will depend on the economic outlook, taking into consideration factors such as banks’ capital trajectories, asset quality, equity markets, etc.
In any case, in order to facilitate banks lending to the economy, the ECB will not expect banks to operate above the level of their P2G any sooner than the end of 2022.
In relation to the LCR, the point in time at which the ECB would expect banks which have previously used their liquidity buffers to once again comply with the general 100% minimum level will depend on both bank-specific (e.g. access to funding markets) as well as market-specific factors (e.g. demand for liquidity from households, corporates and other market participants). In any case, the ECB will not expect this any sooner than the end of 2021.
The 2021 EBA Stress Test is expected to inform the setting of P2G levels. Do you foresee any impact on the P2G levels?
Indeed, the 2021 EBA Stress Test will inform the setting of P2G levels going forward, and therefore P2G levels are expected to be revised. However, the ECB does not intend the updated P2G levels to be fully met by banks before the date when banks are expected to again meet their P2G (see previous question). The ECB in particular intends to give banks sufficient time to replenish their capital in cases of increased P2G levels.
You said banks can continue to operate below P2G levels until at least the end of 2022. What does this imply for banks who may pay out dividends?
The ECB considers that banks need to maintain a sufficiently large amount of capital to absorb potential losses and support the real economy by providing credit to households, small businesses and corporates.
As a guiding principle, banks whose capital levels are sustainable from a forward-looking perspective may be allowed to pay out an appropriate level of dividends using conservative and prudent assumptions, taking into account the mandatory restrictions on distributions provided for in the Capital Requirements Directive.
What are the implications of the ECB stance on the buffer/P2G use for less significant institutions?
The ECB expects the national competent authorities to apply the same treatment to the less significant institutions as the ECB is applying to the significant institutions.
You have decided to return to a bank-by-bank assessment of capital and distribution plans. Why, and why now?
The recommendation for banks to suspend and then to curtail their distributions was an exceptional measure intended for exceptional circumstances. We had previously expressed our intention to go back to a bank-by-bank assessment in the absence of any materially adverse developments. The latest macroeconomic projections confirm the economic rebound and point to a further reduction in the level of economic uncertainty, which is improving the reliability of banks’ capital projections when compared to the beginning of the pandemic. These elements allow us to repeal the recommendation with effect from the end of September 2021. Supervisors are well prepared to go back to the previous supervisory practice of discussing capital trajectories and dividend or share buy-back plans with each bank in the context of the normal supervisory cycle.
Is it prudent to let banks pay dividends now when you recently said banks’ balance sheets and NPL ratios still do not fully reflect the impact of the pandemic?
Over the past year, we have specifically focused on the adequacy of credit risk processes to identify weaknesses in the identification, classification and measurement of credit risk, as explained in the July 2021 blog post on credit risk controls. Our aim was to prevent a build-up of vulnerabilities, as weak controls and processes have resulted in undue increases in problematic loans in previous recessions.
Even though the full scale of issues related to COVID-19 has not yet materialised, we are confident that our review will help banks deal with upcoming challenges, including a potential increase in non-performing exposures on their balance sheets, as support measures expire. As supervisors, we will maintain a close scrutiny of credit risk developments related to the impact of the pandemic. We will react using our supervisory toolkit where we see any build-up of risks. We do not see our dividend recommendation as being part of our standard supervisory toolkit.
What does it change in concrete terms? Which criteria are you going to look at to assess banks’ dividend plans? Will you take the outcome of the 2021 stress test into account in your assessment, as other authorities do?
Going forward, we expect banks to communicate early with their supervisors about their distribution plans before announcing them to the markets. We see the assessment of capital trajectories as an important element in the ongoing supervisory dialogue; dividend and share buy-back plans are an important element of this assessment along with other management actions (e.g. capital increases, management of risk-weighted assets, structural measures to improve profitability). Supervisors will thoroughly assess banks’ plans to distribute dividends and conduct share buy-backs on an individual basis in the context of the supervisory cycle after a careful forward-looking assessment of capital plans.
In assessing banks’ dividend plans, supervisors will take into account the resilience of banks’ capital generation capacity, the quality of their capital planning framework (including the management of cliff effects from transitional arrangements and the reliability of the underlying macroeconomic assumptions), and the potential impact of a deterioration in the quality of exposures, including under adverse scenarios. Banks with robust capital trajectories are those that can demonstrate that uncertainty around adverse asset quality developments in the coming years can be covered by sufficient capital generation capacity or credible management actions.
Stress test results will also be considered. Supervisors will use the stress test results to detect vulnerabilities in banks’ risk profiles and to inform the assessment of distribution plans. At the same time, we do not see the stress test results as being a test to automatically determine whether and how much banks should remunerate their shareholders, as regulatory mechanisms such as the maximum distributable amount (MDA) are already designed for this purpose.
What are the next steps? When are you going to assess banks’ dividend plans? When do you expect banks to start paying dividends?
Banks submit their financial and capital projections to the ECB on a regular basis, including their projected distributions over a three-year period. The frequency with which we receive updated projections from banks has increased during the COVID-19 crisis. This has helped us refine our supervisory toolkit. JSTs will hold their supervisory dialogue discussions with banks over the summer, using the latest capital projections available. Through this dialogue, supervisors will give feedback on their forward-looking capital adequacy assessment to banks, which are expected to take this into account when formulating their final dividend distribution plans. We anticipate that a number of banks will conduct share buybacks, distribute part of the reserves accumulated or dividends suspended over the 2019 and 2020 financial years in the fourth quarter of 2021, after the recommendation is lifted on 30 September 2021.
What are the ECB’s expectations on variable remuneration after 30 September 2021?
In December 2020 we sent a letter to banks to outline our expectations that banks adopt extreme moderation with regard to variable remuneration over the same period foreseen for limiting dividends and share buy-backs (until 30 September 2021). Since then, we have carefully monitored banks’ pandemic-related decisions on remuneration: we are broadly satisfied with the measures undertaken, as several banks have adjusted their plans (such as reduction/cancellation of the variable remuneration bonus pool, deferral for a longer period of time and payment of variable remuneration in instruments). We have also seen a broader improvement by banks in their remuneration policies and practices, our supervisory action will further spur banks in that direction.
The latest macroeconomic projections point to a nascent economic recovery and a further reduction in the level of economic uncertainty. Against this background, banks are no longer expected to exercise extreme moderation in their remuneration policies in relation to the COVID-19 crisis.
In line with the EU regulatory framework, the ECB expects banks to adopt a prudent, forward-looking stance when deciding on their remuneration policy, as communicated to banks before the pandemic (SSM-2020-016). Institutions should carefully weigh the potentially detrimental impact of remuneration on the objective of maintaining a sound capital base. Such supervisory expectations are guided by the principle of proportionality as situations vary considerably, depending on factors such as the banks’ remuneration practices, business model and size. Our expectations apply to both significant supervised entities and individual institutions that are not part of a significant supervised group.
You granted leverage ratio relief to banks i.e. you allowed banks to temporarily exclude central bank exposures from their leverage ratio. What exactly is the leverage ratio and why is it a backstop? What is the leverage ratio relief doing?
The leverage ratio shows the relationship between a bank’s Tier 1 capital and its total exposure measure. The total exposure measure includes the bank’s assets and off-balance-sheet items, irrespective of how risky these are. Because the leverage ratio doesn’t depend on risks, the leverage ratio requirement serves as a simple, non-risk-based backstop to risk-weighted capital requirements. The 3% leverage ratio requirement becomes binding for banks on 28 June 2021.
The leverage ratio relief the ECB announced in the press release of 18 June 2021 means banks can exclude certain central banks exposures from their total exposure measure i.e. from the denominator of the leverage ratio.
Only the central bank exposures newly accumulated since the beginning of the pandemic effectively benefit from this leverage ratio relief. The level of resilience provided by the leverage ratio before the pandemic is therefore maintained. This is done via an upward recalibration of the 3% leverage ratio requirement: a bank which decides to exclude central bank exposures from its total exposure measure needs to recalibrate its 3% leverage ratio requirement, meaning its leverage ratio requirement won’t be 3% anymore but a bit higher.
Banks can choose whether they want to use this relief measure, i.e. banks do not necessarily have to exclude the central bank exposures and recalibrate their leverage ratio.
How does the upward recalibration of the 3% leverage ratio requirement work in practice?
The recalibration ensures that only the increase in banks' central bank exposures since end-2019 would in practice lead to leverage ratio relief. In the example below, the bank would recalibrate its 3% leverage ratio requirement to 3.15%. This way, only the central bank exposures newly accumulated since the beginning of the pandemic (16 euros in the example below) effectively benefit from the leverage ratio relief.
Why did you choose 31 December 2019 as a reference date for the recalibration of the 3% leverage ratio requirement?
The reference date chosen for this recalibration is 31 December 2019, as it is the last end of quarter before the pandemic, based on the start date of the supervisory and monetary policy measures implemented in March 2020.
What other measures can we expect?
Taking into account the economic and financial developments so far, and the gradual return to normality at most banks, the ECB currently does not foresee the need for measures beyond those described above. The ECB will continue to closely monitor the evolving coronavirus pandemic and its implications for the banking sector, in close contact with other authorities and the banks we supervise.
BCBS Statement: https://www.bis.org/publ/bcbs_nl22.htm
[BCBS statement extract]
While each of these buffers seeks to mitigate specific risks, they share similar design features and are all underpinned by the following objectives:
- absorbing losses in times of stress by having an additional overlay of capital that is above minimum requirements and that can be drawn down; and
- helping to maintain the provision of key financial services to the real economy in a downturn by reducing incentives for banks to deleverage abruptly and excessively.
The Committee continues to be of the view that banks and market participants should view the capital buffers set out in the Basel III framework as usable in order to absorb losses and maintain lending to the real economy. In practice, the Basel capital buffers are usable in the following manner:
- banks operating in the buffer range would not be deemed to be in breach of their minimum regulatory capital requirements as a result of using their buffers;
- banks that draw down on their buffers will be subject to the automatic distribution restriction mechanism set out in the Basel III framework; and
- supervisors have the discretion to impose time limits on banks operating within the buffer range, but should ensure that the capital plans of banks seek to rebuild buffers over an appropriate timeframe.