FIN.

Covid-19 – PRA writes to CEOs on IFRS 9 and capital requirements

On 26 March the PRA, wrote to CEOs of UK banks and building societies providing guidance on the application of the definition of default in the CRR in light of Covid-19, and the expected credit loss accounting (“ECL“) requirements of IFRS 9. Much of the guidance related to payment holidays, moratoria or deferrals (“payment deferrals“).

As the first payment deferrals are coming to an end, PRA wrote a second letter to CEOs on 4 March updating the March guidance to address exits from initial payment deferrals.

Principles underlying PRA’s guidance

When there has been a payment deferral, counting of days past due should be based on the agreed schedule for the purposes of the ECL backstops and for the CRR definition of default. However, loans that are not past due can still have suffered a significant increase in credit risk (‘”SICR“), credit impairment or default.

  • Eligibility for, and use of, Covid-19 related initial and further payment deferrals taken up in line with the FCA guidance does not on its own automatically result in a loan (a) being regarded as having suffered a SICR or being credit-impaired for ECL, or (b) triggering a default under CRR. Firms will need to consider other indicators to determine the appropriate treatment. For example, for CRR purposes, firms should assess whether the deferral should be considered a distressed restructuring and in cases where it is likely to result in a diminished financial obligation this may be an indication of default.
  • Firms will likely have limited borrower-specific information to make the determinations on an individual borrower-basis. They should thus make holistic assessments that look beyond past-due information and use of payment deferrals in order to treat such loans appropriately for accounting and regulatory purposes.
  • PRA does not envisage that these holistic assessments for accounting and CRR purposes will be made at the time when a payment deferral is taken up. These assessments are expected to be made subsequently and be based on the information available at the next and reporting dates.

 

The illustrative examples in the Monetary Policy Review and Interim Financial Stability Review

The letter also briefly considers the BOE’s Monetary Policy Committee’s latest Monetary Policy Report (“MPR“), published in May 2020, which contained an illustrative economic scenario based on assumptions about the pandemic and government, household and business responses to it. PRA considers that this illustrative scenario might be one of many useful data points to take into account in developing forward-looking scenarios for ECL purposes.

The letter then considers the Interim Financial Stability Report (“FSR“) published by the FPC, which sets out a desktop stress test designed to explore the losses that the major UK banks and building societies might experience in the MPR’s illustrative scenario.

This stress test was intended to enable FPC to make judgements on whether the core banking system would have sufficient capital buffers and capacity to provide credit to support the UK economy.

However, the letter acknowledges that the test did not draw on submissions from banks. PRA intends to gather further information from firms on estimated provision levels to compare the timing and amount of losses modelled under the stress test to those anticipated by banks. This information will, the letter explains, enable PRA to identify any significant outliers and further refine its estimates for future capital exercises.

Amelia Green