By Tobias Adrian and Ceyla Pazarbasioglu
The massive macro-financial shock caused by the pandemic continues to ravage the global economy and has put both banks and borrowers under severe strain. Supervisors find themselves confronted with unprecedented challenges, which call for decisive action to ensure that banking systems support the real economy while preserving financial stability. This piece introduces nine joint IMF-World Bank recommendations to help supervisors navigate these uncharted waters and calls for vigilance regarding policy measures that are not consistent with international standards. This is critical to prevent the health and economic crisis from morphing into a financial crisis.
The massive macro-financial shock caused by the pandemic continues to ravage the global economy and has put both banks and borrowers under severe strain. Supervisors find themselves confronted with unprecedented challenges, which call for decisive action to ensure that banking systems support the real economy while preserving financial stability. This blog introduces nine joint IMF-World Bank recommendations to help supervisors navigate these uncharted waters and calls for vigilance regarding policy measures that are not consistent with international standards. This is critical to prevent the health and economic crisis from morphing into a financial crisis.
The banking sector plays a critical role in mitigating the unprecedented macroeconomic and financial shock caused by the pandemic by supporting affected borrowers and maintaining the flow of credit to the real sector while preserving financial stability. The global banking system is on a much stronger footing now than during the 2008 financial crisis, due to the implementation of the G20’s financial regulatory reforms. Still, as acute liquidity challenges give way to structural solvency problems, defaults on debt will rise and the pressure on the banking system will grow. Further adverse shocks to economic and financial conditions could occur. The lingering uncertainties about the ultimate length and impact of the shocks also pose profound challenges to banking supervisors.
The IMF and the World Bank share a long-standing and key strategic partnership to help our member countries preserve financial sector stability and promote financial development. Our joint efforts are now more important than ever.
Banking supervision and regulation is an area in which both organizations have extensive experience. Drawing from insights of IMF-World Bank operations across our global membership and our joint Financial Sector Assessment Program, we have published a joint IMF-World Bank staff position note, which sets out nine recommendations that can serve as a guide for banking supervisors as they navigate these uncharted waters.
What have policy makers done?
To provide immediate relief to affected borrowers and maintain adequate liquidity in the financial system, many national authorities have deployed support measures such as debt repayment postponement, stimulus packages, and credit guarantees.
Supervisors have been an integral part of this policy response. Building on the guidance of standard setting bodies, many supervisory authorities have implemented a wide range of interventions in the financial sector. The measures target utilization of available bank capital and liquidity buffers, provide clarity on regulatory treatment, promote balance sheet transparency, and maintain the operational and business continuity of banks as well as payment systems.
What should supervisors bear in mind?
Our recommendations recognize the continuing effort to support the immediate needs of the real economy, while ensuring financial stability. They encourage national authorities to employ the embedded flexibility of regulatory, supervisory, and accounting frameworks, while upholding internationally agreed minimum regulatory standards and supervisory principles. Abandoning such principles could sow the seeds of future risks that would potentially undermine the medium-term soundness and health of the banking system.
Particular vigilance is necessary regarding measures that are not consistent with internationally agreed frameworks. Indeed, some developing countries have fewer policy options at their disposal, due to limited policy buffers, weaker implementation capacity, and less-sophisticated regulatory frameworks. This could explain their higher reliance on policy responses that are not in line with our recommendations. These risk jeopardizing some of the hard-won gains in regulation and supervision that underpin financial stability in developing countries.
The role of the bank supervisor has never been so essential.
Recommendations to guide bank supervisors in their response to the pandemic
- Use the flexibility in the regulatory and supervisory framework while upholding minimum prudential standards and preserving consistency with international standards.
- Facilitate well-designed public and private support interventions that target affected borrowers and sectors.
- Minimize opportunities for moral hazard and maintain adherence to sound credit risk management practices, while facilitating the effective allocation of new credit.
- Provide guidance on asset classification and provisioning, building on the guidance from Standard-Setting Bodies (SSBs), and refrain from relaxing the regulatory definition of nonperforming exposures.
- Maintain transparency and provide additional guidance on risk disclosure.
- Suspend the automatic triggers of corrective supervisory action while dealing with the extraordinary circumstances of the pandemic.
- Review supervisory priorities and maintain close dialogue with the industry.
- Coordinate actively with supervisory colleagues, domestically and internationally.
- Ensure the smooth functioning of critical market infrastructures.
How do the recommendations help keep the financial system in good health?
If the blood pressure of a person increases, adjusting the medically acceptable blood pressure range upwards may prevent a red alert on the hospital’s monitor, but it doesn’t mean that the patient is not at risk. Similarly, changing the way in which the “vital signs” of the banking sector (capital, liquidity, asset quality) are defined and measured will not help keep the banking system healthy.
For example, some jurisdictions have frozen the asset classification status and provisioning requirements for loans that were performing before the start of the pandemic or have changed the definition of non-performing loans by extending the number of past due days. This approach risks missing vital signs if part of the loan portfolio is structurally impacted and performance weakens. While temporary measures may help buy time until a clearer view on the impact of the pandemic is possible, recommendation 4 calls for supervisory action to ensure that banks continue to monitor their asset quality using well-established standards and build adequate provisions over time. This approach ensures that the banks’ vital signs are properly measured, which facilitates management actions and prompts early supervisory actions if and when warranted. To lay the foundation for a sustainable recovery, it is also essential to provide clear guidance on asset classification and provisioning and to ensure that measures are well designed, time-bound and targeted.
By encouraging the use of the flexibility in the framework, while upholding minimum standards, the recommendations seek to ensure that the healthy vital signs of the banking system are transparently maintained and supervised. This will help minimize the risks of a damaging financial crisis that would compound the major economic costs of the pandemic.
The IMF and the World Bank have taken a unified position to assist and support our member countries. These joint recommendations aid the development, monitoring, and strengthening of policies to sustain financial health during this pandemic and, equally important, for the road to recovery.
Adrian is Financial Counsellor and Director of the IMF’s Monetary and Capital Markets Department, while Pazarbasioglu is Vice President, Equitable Growth, Finance and Institutions (EFI), World Bank Group.
This article was originally published on https://blogs.worldbank.org/voices/