by supporting affected borrowers and maintaining the flow of credit to the real sector while preserving financial stability. 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 poses profound challenges to banking supervisors.
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.
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.
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.