The new 2022 Banking Regulation guide features 22 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 13, 2021
It almost seems trite to point out that 2021 has been another unprecedented year. COVID-19 has caused economic activity to whipsaw in the past 18 months, with public sector activity playing a fundamental role in both relieving the downturn and stimulating a subsequent resurgence in economic activity. The waves of governmental financial support through the crisis, coming on top of already unprecedented levels of central bank liquidity and reduced economic capacity, are driving significant inflationary pressures. In the Western economies, a new generation of indebted borrowers is on the verge of discovering the dangers of rising interest rates.
Are We Due a Post-COVID Reckoning?
It remains the case that, to date, the economic fallout of the COVID-19 crisis has been managed highly successfully by governments in most developed nations. Liquidity constraints have been met by unprecedented public sector support – which has served as a palliative to the immediate crisis, but has also resulted in massive increases in sovereign debt. The banking sector has played a key role in keeping credit markets open, supported by positive action from regulators.
Starting from stronger balance sheets than in 2009, and largely cushioned from the immediate effects by the actions taken by regulators, banks have come through the initial wave of COVID-19 relatively unscarred, and the wave of governmental support has deferred, if not eliminated, the wave of restructurings and liquidations that might otherwise have been expected.
Challenging times lay ahead, though. Government support cannot last forever, and rising inflation (and possibly, in due course, interest rates) is likely to exacerbate solvency difficulties for heavily indebted borrowers in the corporate and retail sectors. Governments and central banks will be walking a tightrope over the next few years to return the role of financing to the market without triggering a debt crisis.
Building the Infrastructure to Restructure
The immediate catalyst for many restructurings will be the withdrawal of government support: governments cannot support closed businesses and fund furloughed staff forever. In 2022 and beyond, a wave of corporate failures and personal bankruptcies will emerge. Pressure on banks’ restructuring capacity is likely to grow as responsibility for financing – and with it for work-outs – is passed back to the private sector. Banks will need to prepare to deal with that wave at scale, whilst maintaining appropriate controls to ensure the fair treatment of their customers. Mechanisms to clean up non-performing assets will likely also be important.
Regulators will expect firms to have learnt the lessons of past foreclosure and restructuring scandals. Furthermore, 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 may become increasingly challenging.
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 weaker 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
Legislators and regulators hit the pause button on regulatory reform whilst the initial wave of COVID-19 swept across the world. Now that the situation has stabilised somewhat, reform is beginning to rear its head again.
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, 2022 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.
Future Challenges: Crypto – a New Shadow Banking Sector?
Looking past the health crisis, cryptocurrency activities remain a regulatory conundrum in need of a solution. Behind the headline-grabbing violent swings in value, the looming spectre of increasing systemic risk derived from the sector as it grows, coupled with some fundamental difficulties associated with regulating decentralised activities, has resulted in something of a regulatory backlash against risk activities relating to cryptocurrencies occurring in the traditional financial sector – most notably through the Basel papers on risk weighting cryptocurrency-related exposures. Ultimately, regulators may struggle to tame the sector in the short term, as they are constrained by inherently national mandates and relatively slow and inflexible legislation. This being the case, pressure may mount at the interface between the two systems, with further pressure placed on banks as the gateway to the payment systems on which participants ultimately rely to redeem fit value for their holdings. The net effect may well be to leave the banking sector to observe activities in cryptocurrencies from the sidelines – at least until the public sector regulates them.
Future Challenges: ESG
To date, the financial sector has been a perhaps surprising focal point for the regulation of environmental, social and governance (ESG) initiatives. In the UK and Europe, at least, regulators have sought to put environmental concerns in particular firmly on the agenda of banks from three perspectives: product offerings, disclosure and risk management. Much of the rest of the world is following, albeit at different rates and with different points of focus. The increasing prominence of green products is an opportunity, but also a risk, for financial services providers. New regulatory risks are emerging for investors and financial institutions, as governments respond to the international commitments states have made to address adverse ESG impacts by companies within their jurisdiction, including with respect to climate change. Managing ESG challenges consistently across business lines and jurisdictions will be a major undertaking in the coming years.