Covid–19 coronavirus: what should banks and other financial institutions focus on?

Bank and financial institutions are seen as of utmost importance in maintaining economic activity and enabling the supply and delivery of basic needs for the population at times of crisis.  Governments and regulators will be forced to develop considerable appetite to relax or suspend currently applicable regulations and introduce some special incentivisation schemes (including guarantee schemes, special liquidity and lender of last resort) to avert catastrophic economic outcomes.

Non-bank participants in financial markets who are not eligible for special liquidity schemes yet finding themselves under mounting losses pressures may be the first casualty in time. They may also act as transmission mechanisms to the banking system. 

We see the following areas as key considerations at this moment for financial institutions:

Capital

Firms need to revise their stress testing assumptions in the near term so that they reflect the severe economic shock expected at both the corporate and retail sector (and possibly at sovereign level in certain cases).  This may be compounded by considerable pressure on financial markets with the prospect of some financial firms getting into significant difficulties and ultimately fail.  Whilst capital buffers have already been relaxed by some supervisors, we expect further dramatic measures with regards to both capital ratios to be forthcoming in the coming weeks. Loan portfolios need to be subjected to stress factors in light of the unfolding situation. Firm must ensure the following:

• Trigger contingency measures to the extent necessary including, in extreme, recovery plans
• Consider potential capital erosion in the near term up to 6 months including recapitalisation options where appropriate and necessary – shareholder engagement
• Reassess group capital repatriation options
• Assess deployment of Pillar II buffer and discuss trigger with regulators
• Assess and discuss leverage constraints and possible relaxation/suspension 
• Consider immediate suspension of staff bonuses and dividend payments (including any share buy-back programmes)

Liquidity

• Daily appraisal of short terms liquidity positions and management reporting, taking account of collateral demands and making use of the spectrum of available central banking facilities
• Daily contact with significant financial regulators to appraise position and discuss contingencies
• Dust off emergency liquidity sources and prepare to deploy
• Prepare and anticipate for major currencies liquidity in particular US Dollar including potential currency control measures
• Consider and discuss with regulators usage of liquidity buffer and triggers for that

Relevant sources:

Basel Committee Standards
Central bank liquidity and government guarantee schemes
Prudential regulator pronouncements
Regulator engagement

Operational capacity

We expect the operational capacity of most financial institutions to be hurt in some cases.  In some cases this will have debilitating service implications for customers and counterparties.  Most developed regulatory regimes have detailed governance requirements around events having this effect with methodical escalation frameworks.  Firms may need to trigger escalation buttons on their own internal contingency plans and/or in response to contingency plan activation of their counterparties, customers and suppliers.  Given the unprecedented nature of the health crisis, firms need to fast consider any steps required to augment, diversify and bolster systems and operational resilience, for example buying additional capacity and/or engaging with additional suppliers in different geographical locations (decreasing dependence on services sources from suppliers predominantly based in one country).

In extreme cases we expect firms to require close regulatory engagement and forbearance.  Persons with specified managerial/regulatory responsibility in the performance of designated operational roles and functions will need to refresh their mind on the nature of their obligations and how these translate into practical steps.  Senior management engagement must be frequent and expansive.

• Stress test operational capacity against regulatory requirements on the basis of new working practices/personnel absence
• Adopt a clear and consistent supervisory engagement with key regulators
• Consider the need to escalate and/or trigger contingency planning/business continuity planning
• Establish a crisis management committee to address matters arising from Covid-19
• Enhance monitoring for early indicators of recovery mode
• Closely monitor critical suppliers/third party contractors’ resilience and anticipate areas where alternative suppliers might be required – proactive engagement and interrogation 

Relevant sources:

Capital Requirements Regulation/Directive
Systems and Controls Rules
Outsourcing Rules
Senior Managers regulations

Customers

Covid-19 will undoubtedly have a marked impact on the economy and in particular on a number of directly affected business areas in the entertainment/hospitality/tourism sector.  Whilst financial institution will have a detailed contractual framework underpinning their rights and obligations, regulatory requirements will have a significant bearing on courses of action and policies that are in fact available.  For example, Treating Customers Fairly and the detailed Conduct of Business obligations will likely dictate that the range of options is more limited or restricted.  Redress rules will also guide firms’ protocols. Whilst this is true in the consumer space where protectionism is the benchmark, it will also extend to Micro, Small and Medium entities which are vulnerable though we expect this to also apply to some large corporates given the scale and magnitude of the expected downturn. 

Moreover, it is likely that customers will challenge contractual obligations on various grounds due to Covid-19.

• Adopt a clear and consistent customer communication plan – preferably tiered 
• Avoid taking enforcement decisions in isolation (either business line or customer type)
• Consider the impact of specific and broad regulatory provisions on options open to minimise financial loss
• Consider any available regulatory incentives and or schemes that would assist suspension/deferral of customer obligations
• Think broad in terms of the reputational risks that may emerge if a particular business practice is publicised 
• Consider the systemic risk/precedent value of each and every decision to enforce/foreclose/refuse new customer relationships

Relevant sources:

Consumer protection regulations
Conduct of Business Rules
Ombudsman/redress schemes
Complaint Rules
Systems and Controls Rules
Senior Managers regulations
Government guarantee schemes

Counterparties/Market conduct

Financial counterparties will no doubt suffer losses during this crisis.  This may be through a combination of defaults, significant resourcing issues, supplier failures and dramatic reduction in economic activity.  It would be prudent to develop a default playbook across the business areas which consider both contractual and regulatory issues arising.  Contagion risk and crystallisation of losses for regulatory capital purposes would be critical (measured against a likely suspension/softening of requirements).  It is therefore imperative that no policies are formulated without a thorough understanding of contractual, regulatory and reputational implications of each proposed systematic course of action.

Public securities, commodities and foreign exchange markets are suffering major dislocations and regulators will vigilantly monitor abusive behaviour.  Equity and sovereign short selling bans and restrictions are being issued and firms must adapt their conduct accordingly, delivering zero tolerance messages to trading staff.  Continued market volatility will afford significant scope for misconduct/conflict of interests during the coming months.  Trading losses will offer incentives for ‘correcting’ and potentially inappropriate trades.

• Have a thorough assessment of the contractual framework – know your rights and obligation and consider any stays on termination provisions and cross-default consequences
• Consider layers of regulatory obligations, specific or broad, and the impact on the choice of available actions
• Have due regard to systemic economic impact and reputational issues – regulators, encouraged by governments, will be acutely alert to those
• Be fully aware of accounting and regulatory capital impact of proposed actions, in isolation and at the level of portfolio of products/activities level
• Monitor temporary restrictions on trading in public markets and enforce trading staff adherence – enhance monitoring and surveillance
• Assess emerging conflict of interests and develop mitigating measures (or restrict certain activities)

Relevant sources

Contractual framework
Conduct of Business Rules
Recovery and Resolution frameworks
Capital Requirements Regulation/Directive
Short selling temporary measures

Financial infrastructure

Financial infrastructure providers (and their members) may face defaults and other operational disruption as a result of enforcement activity intensifying.  Markets will be volatile and trading venues may be severely disrupted.  Firms must assess the infrastructure most critical to their operations and maintain a close conversation including, where applicable and necessary, contemplating engagement with alternative providers.  Terminating indirect access to infrastructure must be done with caution given the likely direct economic impact.

• Maintain regular communication with critical infrastructure providers
• Consider whether any contingency actions are required with regards to alternative arrangements
• Project whether extra funding/collateral would be required due to expected default
• Consider internal restrictions/limits on interaction with infrastructure providers

Relevant sources

Operational resilience Rules
Outsourcing Rules
Systems and Controls Rules

Regulatory incentives/Government guarantees

We expect a slew of regulatory and central bank incentives and government guarantees to emerge in the coming days and weeks to ensure that there is a flow of funds to the real economy and in particular to the micro, small and medium entity segment. It is important that firms are attuned to global schemes and analyse them in detail in order to inform their business and risk appetite with regards to ‘in-scope’ businesses and customers. Part of this will involve advocating to governments and regulators for forbearance and dispensation where required in case firms’ data, particularly firms with significant view of the market, would suggest that certain new steps are required to expand or deepen scope of intervention.

• Assess each relevant scheme in a timely manner and advise relevant stakeholders – develop policy on utilisation
• Prioritise relevant schemes and ensure operational eligibility and implementation
• Assess significant product/customer segment default developments and inform regulators and government of likely areas where further/augmented schemes would be required

Regulatory reporting and disclosure/Compliance

With reduced resourcing available and growing reporting and filing demands on firms, it is conceivable that regulators will be amenable to granting general and/or firm specific dispensations for reporting data which is not deemed as significant or systemically important. 

This is particularly true to new or emerging requirements which are not yet in force, so called ‘in-flight’.  There is a broader point around implementation of new regulatory measures which may either be delayed or where it may be sensible to advocate for suspension/ regulatory forbearance.

Many regulatory rules will have to be reconsidered in the context of sustained remote working (see CFTC relaxation of telephone recording obligations).  Particular attention must be drawn to market disclosure obligations for listed entities.