The COVID-19 pandemic is the "first real stress test" for banking capital regulation reform made following the global financial crisis, and will inevitably trigger revisions in regulators' approach, David Mathers CFO of Credit Suisse Group AG said June 10.
Some regulations may be reviewed following the experience of the past few months during which global watchdogs eased capital requirements to help banks offset increased procyclicality effects, Mathers said, speaking at the Goldman Sachs European Financials Conference 2020.
Increased procyclicality is in focus due to the interaction between the Basel III capital framework, and post-financial crisis accounting standards, which state that banks must make provisions for expected rather than incurred losses and mean provisions spike during a downturn and fall in good times.
Banks had already raised concerns about the negative procyclicality effects of the expected-loss model, but the health crisis showed for the first time how much provisioning volatility the model could trigger. Provisions doubled, tripled, and even quadrupled for many European banks as COVID-19 lockdowns caused economic activity to grind to a halt. U.K.-based HSBC Holdings PLC, which booked the highest loan loss provisions among the biggest banks in Europe, saw its provisions surge more than 400% year-over-year to €2.75 billion.
The top five U.S. lenders by assets, including JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc., Wells Fargo & Co., and U.S. Bancorp, also saw their aggregate provisions rise five times year over year to $24 billion.
Credit Suisse reports under the U.S. Current Expected Credit Losses, or CECL, standard rather than the International Financial Reporting Standard 9, or IFRS 9, adopted by its European peers. The CECL approach is even more procyclical than IFRS 9 because it requires lifetime provisions for all loans, while IFRS 9 requires only 12-month provisioning for performing loans, the CFO said, adding it is "not helpful" to have two different standards.
The bank set aside reserves equivalent to 88 basis points of loans, similar to the range seen by big U.S. banks, Mathers told the conference.
On exempting central bank deposits from the leverage ratio of banks, Mathers said it is a "helpful" measure, but it makes no sense to keep it only to the end of the year. "It should be for an indefinite period," he said, adding that holding capital against deposits with the Swiss National Bank, a risk-free institution, seems to weaken the definition of the Basel Committee on Banking Supervision definition of the leverage ratio. "So I think it is more important these things become more permanent rather than temporary," Mathers said.
Under the Basel III regulatory framework, the leverage ratio measures a bank's total Tier 1 capital against its total assets which means capital is held against all balance sheet items regardless of the risk they carry. Therefore, holding more central bank deposits would lead to a drop in leverage ratio without any actual increase in the bank's risk.