Banking Regulation 2021

The new 2021 Banking Regulation guide features 17 jurisdictions. The latest guide covers the requirements for acquiring or increasing control over a bank; corporate governance; anti-money laundering (AML) and counter-terrorist financing (CTF) requirements; depositor protection; capital, liquidity and related risk control requirements; insolvency, recovery and resolution of banks; and the latest regulatory developments.

Last Updated: December 10, 2020

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Allen & Overy has an international financial services regulatory team that is a strategic partner to the world’s leading financial institutions, guiding them through an increasingly complex regulatory landscape where national and international regulations may interact or conflict. With more than 80 financial services regulatory experts across its international network of offices, the firm brings the breadth and scale a global business needs, as well as an understanding of the local environment. It helps clients plan for and navigate the complex developments and challenges they are facing, protecting them from regulatory risk and advising them on how to take advantage of emerging opportunities. The group brings together an impressive list of leaders in their field, and amalgamates specialist expertise from the firm's Banking, Payments, Capital Markets, Investigations and Regulatory Enforcement practices, along with A&O Consulting and Markets Innovation Group (MIG) colleagues, supported by the advanced delivery and project management teams. This cross-practice, multi-product, international offering provides clients with greater access to market-leading expertise and innovative products and solutions tailored to their very specific, highly complex needs.


2020 has been an unprecedented year in many respects. For financial market participants, the legacy of the COVID-19 crisis will far outweigh and outlive the disruptions of Brexit and the US election (and the re-regulation that is likely to follow each). Whereas a financial crisis spawned an economic crisis 12 years ago, this time the process is being reversed – the economic repercussions of the COVID-19 crisis will almost inevitably precipitate a financial crisis.

A Job Well Done, but Just Begun

It is safe to say that, to date, the economic fallout of the COVID-19 crisis has been managed highly successfully by governments in most developed nations. The widespread lockdowns to stanch the spread of the disease have posed unprecedented strains on the liquidity of real economy actors, and begun to create (or exacerbate) solvency issues for businesses and individuals. Liquidity constraints have been met by unprecedented public sector support – which has served as a palliative to the immediate crisis, but also resulted in massive increases in sovereign debt. Regulators have also taken a "carrot and stick" approach to ensure banks continue lending – by requiring payment holidays (and in the case of the UK regulator, requesting that banks not enforce covenant breaches – the "stick"), but also by measures discouraging writedowns or increases to capital requirements for COVID-affected exposures (the "carrot"). There have also been welcome deferrals of regulatory reform across many developed jurisdictions.

To date, banks’ responses have largely met the needs of regulators: starting from stronger balance sheets than in 2009, and largely cushioned from the immediate effects by the guidance, banks have in any event had little incentive to enforce defaulting loans in light of the practical difficulties of doing so. As we emerge into the next phase of the crisis, that position is expected to change. The pandemic’s effects are starting to show on the balance sheet of the banking sector, and on that of the sovereigns to which they are tied; new prudential and conduct challenges will emerge; and banks’ incentives will change.

Building the Infrastructure to Restructure

The immediate catalyst for the change will be the beginning of withdrawal of government support: governments cannot go on borrowing to support closed businesses and fund furloughed staff forever. Many businesses will simply have run out of money in lockdown; still more will do so as economic activity fails to rebuild to pre-crisis levels. In 2021 and beyond, a wave of corporate failures and personal bankruptcy will emerge. Banks will need to prepare to deal with the wave at scale, whilst maintaining appropriate controls to ensure the fair treatment of their customers.

Potential Barriers to, and Regulatory Conflicts in, Restructuring

Regulators will expect firms to have learnt the lessons of past foreclosure and restructuring scandals. Furthermore, in a post-COVID environment, the exercise of lenders’ rights against real economy participants – particularly individuals and SMEs – will be highly politically sensitive. That sensitivity is likely to make itself felt through continued barriers to the enforcement of lenders’ rights – be they legislative, regulatory (moratoria, and also conduct-derived impediments to rapid workouts), or reputational.

In this environment, reconciling banks’ prudential and conduct obligations will become increasingly challenging. Prudential regulation is "selfish", in that it prioritises the safety and soundness of individual banks, while conduct regulation is "altruistic", in that it looks to the interests of clients. We currently have the rather strange (from a regulatory perspective) phenomenon of Pollyanna-ish prudential regulators leaning on banks to keep lending to support clients (and society), notwithstanding risks to their own financial health. This will need to change; the key question is when. One of the lessons from the last crisis was that banks which took early decisive action to deal with balance sheet distress fared better than those that did not: if the right balance of interests is not struck, then the banking system will be jeopardised. Banks will need to seek to ensure that such balance is struck through regulatory liaison.

Recognition of Impairments: You Can’t Fool All of the People All of the Time

The removal of government support will also trigger changes to banks’ assessment of credit risk. A variety of measures have been taken to mitigate the immediate effects of the crisis on banks' balance sheets. Accounting and regulatory forbearance does not change the underlying realities of stress, however, and banks will feel the scrutiny of investors and rating agencies, which will want to understand banks’ assessments of impairments and will view regulatory ratios with greater scepticism. Depending on the depth of the crisis, the palliatives delivered by accounting and prudential changes may strain the credibility of banks’ disclosures: sophisticated investors and counterparties may look past regulatory ratios to other, more credible measures. Banks will need to consider their disclosure more carefully than ever.

Debt to Equity: Who Takes the Equity?

The withdrawal of government support will also affect the inevitable reappraisal of banks’ capital positions, as they confront the deterioration in the credit of non-defaulting borrowers. Support measures will typically have resulted in significant increases in borrowers’ leverage: combined with a more difficult trading environment, this will leave survivors in a more precarious financial position. Restructurings, in which the banking sector will play a key role, will be needed in order to return many businesses to a sustainable financial model. It is not clear that bank regulation currently provides all the right incentives in this respect, however. In particular, the regulatory framework penalises equity holdings by banks: for example, in the EU, banks’ material holdings of equity are deductible from capital under the so-called "qualifying holdings" rules, and recent changes to the Basel framework have increased the capital costs to banks of holding shares. This may prove a barrier to banks being part of the solution, meaning that structural solutions ("bad banks", asset management vehicles or the like) are needed.

The Re-emergence of the Doom Loop

The price tag for the pandemic has thus far been paid largely by sovereigns. In the longer term, banks (particularly EU banks) are at risk from the re-emergence of the bank-sovereign doom loop that caused stress in various Southern European Member States. There is little that banks can do to manage this risk, but it will need to be factored into planning for the medium term.

Learning to Live with the New Normal

Outside the prudential sphere, changes to working patterns look unlikely to unwind in the near future. The migration to a more flexible working structure brings with it diverse challenges for banks – particularly around oversight and market conduct. Regulators will expect firms to identify, manage and monitor the risks associated with remote working. Banks are likely to need to rely on technology to replicate the oversight generated by physical proximity, which brings with it privacy and data protection issues to work through.

Bank regulation becomes political in a crisis. Looking forward, 2021 will hopefully see the beginning of the end of the health crisis, and the resumption of some semblance of business as usual. It will take longer for the financial consequences to work through: we anticipate further deferrals of bank regulatory reform to permit the financial sector to absorb and accommodate those consequences, but also a more interventionist approach by regulators to ensure that banks continue to support recovery in national economies.

Author



Allen & Overy has an international financial services regulatory team that is a strategic partner to the world’s leading financial institutions, guiding them through an increasingly complex regulatory landscape where national and international regulations may interact or conflict. With more than 80 financial services regulatory experts across its international network of offices, the firm brings the breadth and scale a global business needs, as well as an understanding of the local environment. It helps clients plan for and navigate the complex developments and challenges they are facing, protecting them from regulatory risk and advising them on how to take advantage of emerging opportunities. The group brings together an impressive list of leaders in their field, and amalgamates specialist expertise from the firm's Banking, Payments, Capital Markets, Investigations and Regulatory Enforcement practices, along with A&O Consulting and Markets Innovation Group (MIG) colleagues, supported by the advanced delivery and project management teams. This cross-practice, multi-product, international offering provides clients with greater access to market-leading expertise and innovative products and solutions tailored to their very specific, highly complex needs.