The economic fallout from the Covid-19 virus has justified the Basel framework reforms – but they will be vulnerable in the aftermath of the crisis. By Justin Pugsley.
What is happening?
The massive stimulus measures unleashed by governments and central banks in response to the coronavirus pandemic are key to sustaining the global economy while medicine and science aim to vanquish the virus.
Banks are also playing a crucial part in sustaining a partially hibernated economy by facilitating stimulus programmes. They can only do so because most of them entered the crisis well capitalised and with a better grip on their operational risks, thanks to the decade-long painful Basel III/IV reforms.
This has meant that prudential regulators have been able to give banks some leniency on their capital buffers, potentially making thousands of billions of dollars of extra capital available to support the economy.
There has also been flexibility around forward provisioning in accounting standards such as IFRS-9, so loans do not quickly become classified as non-performing. Otherwise, capital released from bank capital buffers would be reabsorbed to provision for bad loans. The argument for relaxing forward provisioning is that the government support measures should mean many businesses will survive to repay their loans once the crisis has passed.
The Basel Committee on Banking Supervision has also delayed the implementation of the last rounds of Basel IV measures to give banks more breathing space to handle the practical impacts of the pandemic, such as having to make 80% to 90% of their staff work from home.
Why is it happening?
Governments mandating the shutdown of more than one-third of economic activity to fight the pandemic by asking people to stay at home is unprecedented. The stimulus measures being unleashed by the authorities are also significantly greater than those taken to tackle the 2007-09 global financial crisis.
Through this support, the authorities are trying to preserve the most badly affected parts of the economy such as automotive, leisure and tourism, so they can revive once the lockdown ends. Allowing them all to go to the wall would create another Great Depression, massively disrupting society and the global economy for years.
Banks have an important role to play by showing leniency to businesses that thrive in normal times, but currently have zero income because no one is allowed to frequent them, for example, bars and gyms.
What do the bankers say?
Bankers approve of the massive stimulus measures and appreciate that the alternative of doing nothing would be dire – despite the awful fiscal implications.
However, they are also glad not to be in the eye of this particular storm and even to be seen as part of the solution. They acknowledge that they are in this fortunate position largely thanks to the Basel reforms, which have strengthened their institutions.
Will it provide the incentives?
Banks have been given many incentives to support the real economy through capital and accounting relaxations, government guarantees for loans, and stimulus measures to sustain temporarily closed businesses and then revive the economy once ‘quarantine’ measures are lifted. It is therefore crucial that they play a full part in supporting the economy and are not seen to exploit struggling businesses.
However, what happens to Basel-inspired prudential measures once the crisis has passed? The assumption is that capital buffers will be restored to their pre-Covid-19 crisis levels and the final reforms will be implemented (albeit a year later than scheduled).
Some industry sources are not so sure. They note, for example, the US temporary suspension of the 3% supplementary leverage ratio aimed at the largest banks. Given that the US has worked to relax this measure for several years, some sources believe it will not be restored once the crisis passes. The new stress capital buffer also potentially relaxes prudential standards for US banks.
Europeans have long disliked the ‘floor’ that restricts how far outputs from bank internal models can stray from the Basel Committee’s less risk-sensitive standardised approach. Many would love to wriggle out of that commitment since it is particularly penalising to European banks, which have long used internal models. Could they delay implementation indefinitely?
The implications is that once the crisis passes – and much depends on how serious it turns out to be – jurisdictions may stray from Basel norms for fear that full compliance would starve the economy of capital.
It would be ironic if this happened, since those very capital standards have put banks in a far better position to handle the current crisis.
