On 19 March, Kees van Dijkhuizen, chairman of the board of ABN AMRO, stated that banks will be part of the solution for the current crisis. Together with ING, Rabobank, de Volksbank and Triodos Bank, they decided to give companies affected by the COVID-19 a six-month delay in loan repayment. Initially, it concerns loans of up to 2.5 million euros, a measure to ease the liquidity problems for companies.
However, finance and risk departments promptly started calculating the impact of this measure. Delaying loan repayments appears similar to a forbearance measure which, under IFRS 9, has a direct impact on determining the provisions. Fortunately, on 25 March, the EBA released additional guidance on how to deal with this measure with regard to IFRS 9. Although it gave more guidance, it is still unclear how banks should deal with provisioning.
The question is: will this measure create non-deferred credit losses and when will this impact occur?
On 26 March, CPB came up with 4 scenarios with estimates of, among other things, economic growth and employment. In the 3rd and 4th scenario, effects on the financial sector are taken into account. Naturally, these are generic scenarios and it depends on the bank to what extent they will be affected.
The effects calculated by the CPB apply to the whole of the Netherlands, but the impact differs per sector. Hospitality, culture & sports, tourism and aviation, for example, are virtually stagnant and other sectors such as the car industry and retail trade are struggling. Depending on the duration of the crisis, turnover will show a large percentage decrease and many employees, flexible workers and self-employed people working in these sectors, will lose their income. Therefore, it is expected that these sectors will be affected the most.
It appears that the question posed above has no easy answer and determining an adequate level of credit provision under IFRS 9 will be difficult. The ‘Financiële Dagblad’ of 27 March contains an insightful article on the application of IFRS 9 in the current crisis. The article includes a plea from banks to prevent the pro-cyclical nature of IFRS 9.
Banks getting started with stress testing
Potential difficulties are not limited to determining the level of provisions under IFRS 9, the challenge in stress testing under ICAAP may prove to be just as big. After the financial crisis in 2008, banks took steps in further developing stress testing based on, among other things, the ‘Principles for sound stress testing practices and supervision’. It now depends on whether it is anchored within the organization in such a way that it supports the current situation. Stress testing looks at more elements than the effects on credit losses alone, but in this case it is an important component.
Banks are now being tested to check whether the infrastructure is in place to allow for a quick insight into the existing portfolios, especially those with increased vulnerability during the current crisis. Is there enough data granularity to provide the models with relevant data? Are the current assumptions in the models still valid?
Fortunately, banks have a great deal of experience with stress testing. However, the current situation requires a different take on the scenarios. When preparing the scenario, it is not only important to include the macro-economic aspects, but also the development of the COVID-19 virus. The latter provides a better insight into the effects and the expected duration of the measures taken. The current crisis also offers the opportunity to compare existing stress test models with the current crisis and with scenarios such as those of the CPB. We must also realize that the cause of this crisis is completely different from that of the crisis in 2008 or crises throughout the 20th century. Therefore, it is of importance to recalibrate the relationships between market indicators.
A challenge lies ahead for risk departments, which are already under a great deal of pressure, to gain insight into the scenarios and the level of credit losses in these scenarios needed for stress testing. Balancing between regulations, scenarios and economic reality will demand a lot from risk professionals. In this case, the following will also apply: “Stress testing is more an art than a science”.
Banks will assuredly become infected by COVID-19, but how large the consequences will be is partly influenced by the duration of the economic measures, the support and economic stimulus measures of various governments and of course the quality of risk management throughout the organization at banks.
Please, do not get stressed yourselves and keep communicating with the relevant stakeholders: business, risk management and also the regulator. We can only survive these difficult times if we make it a joint effort.