Post scriptum: temporary modifications to banking law and regulation in response to the Covid-19 public health emergency

Overview of the global pandemic and its implications for the financial services

The Covid-19 crisis which erupted in early 2020 has severely impacted the financial sector in terms of its market activity and market prices, as a consequence of adversely affecting the real economy, i.e. firms and human capital. At the time of writing, the pandemic outbreak had forced national governments to announce extensive lockdowns of society and the economy. These lockdowns resulted in the freezing of business activity for many sectors, such as bricks and mortar retail (except groceries and pharmacies), travel and leisure, restaurants, public services and service-based industries that were adversely affected by social distancing such as transport, work-sharing facilities, leisure and hospitality. The freezing of business activity in these hard-hit sectors has had implications for their cash flow, servicing of debt, potential insolvency and hence their market valuation and credit ratings. Besides public finance packages for emergency help, such as furloughing, financial regulators’ initiatives play a part in the overall mosaic to prevent systemic damage to the economy and to the financial sector’s roles in risk and investment allocation.

In the UK, the financial regulators, i.e. the Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA), released temporarily the application of certain regulatory laws and issued extraordinary measures to regulated entities to suspend the application of private contractual laws. In-built flexibility in law and regulation reflects the dynamic needs of policy and institutional tenets, and although regulated subjects, markets and stakeholders would theoretically be conditioned to expect the possibility of adjustment, the uncertain extent and duration of adjustment still raises issues in terms of the governance of regulatory discretion and external reactions. For instance, the PRA’s guidance to its regulated entities in relation to cancellation of dividends was upsetting for banks and their shareholders despite being part of the overall prudential regulation adjustment package.

On the other hand, the PRA’s guidance on regulated entities drawing down their usually 100% mandatory liquidity coverage ratio[1] is somewhat ‘unexpected’ complement to in-built flexible regulatory measures such as the counter-cyclical buffer (CCyb). Further, the PRA’s and FCA’s guidance to payment holidays for consumers suspends clear and inflexible contractual frameworks that govern creditor-borrower relationships, feeding into the prudential treatment of defaults and non-performing loans (NPLs).° In this respect, the European Banking Authority’s (EBA) similar guidance to national regulators in the EU also manifests the bundling of regulatory suspensions, extending the aura of inherent flexibility to justify and legitimise the co-option of other adjustments not inherently envisaged. In parallel, the FCA introduced adjustments to mandatory procedural law for company meetings and mandatory disclosure for corporate fund-raising, accompanying the relaxation of pre-emption rights.

The pandemic crisis revealed a key public policy concern: how would credit arrangements affect households and corporations that are either in debt or need financing by debt in order to meet financial needs during the challenging period. The package of responses from the PRA and FCA regarding banks’ role in the crisis was intended to meet the policy goal of keeping credit lines flowing and providing liquidity for businesses and households. This package comprises various measures designed to achieve two broad effects. One is to allow banks, as the main creditor of most households and corporations, to be able to treat their borrowers more leniently. This permits borrower battered by the lockdown to be relieved of the pressures of debt while regrouping themselves and surviving during the crisis. Two, the crisis-fighting regulatory measures would also allow banks to extend credit and finance to business borrowers during the crisis. This would help businesses avoid key social losses such as protecting jobs and inflicting knock-on effects upon their suppliers.

  • [1] PRA, ‘Q& A on the Usability of Liquidity and Capital Buffers’ (20 April 2020) PRA, ‘Letter from Sam Woods ‘Covid-19: IFRS 9, Capital Requirements and Loan Covenants’ (26 March 2020) . See also ‘Letter from Sam Woods “Covid-19: IFRS 9 and Capital Requirements -Further Guidance on Initial and Further Payment Deferrals’” (4 June 2020) https://www.bankofengland. 3 EBA, ‘Our Response to Coronavirus (Covid-19)’ (12 March 2020) 4 FCA, ‘Technical Supplement - Working Capital Statements in Prospectuses and Circulars during the Coronavirus Epidemic’ (8 April 2020) 5 FCA, ‘Joint statement by the FCA, FRC and PRA’ (26 March 2020) Thomas Huertas, ‘Here Is How Banks Can Help Save the Economy’ Financial Tinies (11 May 2020)
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