For many challenger banks, COVID-19 will be their first true financial crisis. Those who are proactive and meet the challenges head-on will likely come out of the crisis stronger.
The current regulatory regime was designed to address the issues that arose out of the 2008 financial crisis. COVID-19 will ultimately raise many new and as yet unknown challenges. This Financial Regulation Insight summarizes the key issues facing challenger banks in the current crisis before taking a more in-depth look at a selection of some of them.
For challenger banks a key issue will be balancing a number of factors which may at times conflict:
- Operational resilience: Operational resilience proposals set out by both regulators, are asking banks to 'keep the lights on' in crisis - and in doing so, they must keep under review every aspect of their value chain. We discussed some of the current challenges in our briefing, Operational Resilience in light of the unprecedented crisis.
- Maturity transformation: banks have a crucial societal role in maturity transformation – the conversion of short term deposit taking liabilities (repayable on demand) into long term products that finance business expansion and individual customers' day-to-day living expenses and property purchases. Whatever governments do to ease the burden on businesses and individuals, it is essential that banks continue to provide their core functions.
- Treating customers fairly: banks must treat their customers fairly, including a rapidly increasing pool of vulnerable customers. In the coming weeks and months, this is likely to mean greater use of forbearance and accommodation for customers in breach of their contractual obligations
- Employees: banks are employers who must do all that is reasonably practicable to ensure the health, safety, and welfare of their employees and others who come into contact with their operations.
- Reputation management: banks are businesses with reputations to protect. Poor decisions now, for example, to prioritise shareholder satisfaction or commercial interests over customers' immediate needs, may damage brands.
- Regulatory and compliance obligations: banks have a range of ongoing regulatory and compliance obligations. Many internal control functions will be stretched.
- Crisis Management Plans
Most plans call for the formation of a Crisis Management Committee. Now would be the right time to form such a Committee. The Board or Risk Committee – depending on the governance arrangements of the firm – will need to delegate powers and responsibilities to the Crisis Management Committee. Terms of reference should be created so that it is clear what matters are reserved to the new Committee and in what circumstances it must seek the approval of the Board.
Decision making may need to be rapid and robust, but we would still firmly recommend noting the key decisions and their rationale. This will aid project planning and execution. Sometimes bold decisions will be needed. Subsequent events may show some of these to be misguided. This should not inhibit decisive action, but it reinforces the need to explain clearly what was done and why not least so that the firm is in a good position to respond to regulators' requests for information during and after the crisis.
- Management Information
In situations such as this, new management information may be needed and existing information may need to be collected and circulated more frequently. Banks will obviously need regular information about loan default rates, deposit withdrawals and the credit status of those to whom it has substantial exposures. They may also need regular information about the operational status and employee workplace attendance of key outsourcing providers. Without meaningful and up-to-date management information banks will struggle to identify any material shifts. They may fail to see imminent threats and possible opportunities. For example, a bank might choose to acquire a contractor that provides a critical service to it rather than risk its failure. We expect that the FCA will soon start requesting data from firms in relation to monitoring COVID-19 impact.
- Regulatory Interventions
Some banks will be actively involved in enforcement investigations or skilled person assessments. Others may have ongoing internal investigations or other projects requiring the provision of regular reports to regulators. Our experience is that regulators are responding pragmatically to reasonable requests for extensions, and even for open-ended delays given the current levels of uncertainty.
However, it is important that firms be proactive and not just allow deadlines to pass. In the weeks ahead firms may need to seek accommodations and waivers from regulators. Those conversations will be difficult if a regulator suspects that the firm has used the crisis to avoid appropriate communication with it. Firms should be alert to their continuing obligations under Principle 11 of the FCA's Principles for Business and PRA Fundamental Rule 7, which require firms to deal with their regulators in an open and co-operative way.
- Customer Relief
Banks amongst others have said that they are ready and able to offer support to customers directly or indirectly impacted by COVID-19. This could include offering or increasing an overdraft or allowing repayment relief for loan or mortgage repayments. Indeed, the FCA is currently consulting on new requirements that would take effect from 9 April 2020, which would provide targeted temporary measures designed as a stop-gap to quickly support users of certain consumer credit products who are facing a financial impact because of the exceptional circumstances arising from COVID-19. Banks can expect numerous requests for relief, and this may stress their resources. Care and sensitivity will be needed, some applicants for relief may (the bank decides) not be entitled to it. Some customers may need greater forbearance than banks can agree to. Banks will need a stable and consistent policy so that they cannot be accused of discriminating against customers or customer-types.
The Government's various business support schemes are being intermediated through banks, and as we write there is criticism that some banks are unfairly refusing loans to some businesses in financial difficulty. This highlights the challenges that banks face, but the key is to document the rationale for such decisions so that any future queries, complaints and regulatory scrutiny can be addressed with the help of an adequate paper trail.
- Corporate Governance
Bank's boards should review the meetings scheduled for the next three months or more with a view to determining which can be cancelled or postponed to create time for regular and emergency meetings on COVID-19 related matters. In-person meetings should be replaced with conference or video calls to help prevent cross-contagion within the board. Boards should also consider whether (i) provisional arrangements are already in place to deal with scenarios where a quorum of the board is unachievable, (ii) alternative directors and/or senior managers have been identified who can step in should a director or senior manager become unavailable and (iii) for broking firms quoted on public markets, how the company and its board will hold its annual general meeting (in line with the statutorily mandated timeframe for holding such meeting) on the basis that it is very likely that the meeting will need to be chaired and held in a particular location as opposed to taking place online.
Key governance and senior management roles within the firm should also be identified. This should include members of the board, management, key risk-takers, compliance and IT support. Deputies for each of these key individuals should be nominated and hand-over procedures and notes prepared to mitigate against the risk of illness making such individuals unavailable. The FCA rules permit the temporary appointment, for up to 12 weeks, of a substitute person for significant influence functions before FCA approved person status is sought.
In the aftermath of COVID-19, the board should assess how the bank has navigated the crisis and what lessons can be learnt. Times of crisis are an opportunity for the board and management to demonstrate robust corporate governance.
- Non-Executive Directors
Circumstances such as these tend to benefit enormously from the input of non-executive directors. Executive management may become preoccupied with operational issues and NEDs can provide crucial balance and context. They will tend to be more aware of what is happening in other firms. Typically they will have more of a governance-orientation than will executive directors. However, the key to good NED engagement is high quality management information. Executive management will have important facts and figures readily to hand, but NEDs will need to have it supplied to them.
NEDs will also need to consider their positions very carefully indeed. Firms may expect more of them than they have in the past. Some may need to slim down their appointments so that they can provide the input required from them. They will need to avoid over-committing.
- Market Disclosures
Some banks will be listed, or be parts of a listed group where the bank's performance is material to the price of the group's issued securities. Issuers are required to inform the public as soon as possible of inside information that directly concerns that issuer. This is essential to avoid insider dealing and ensure investors are not misled. In its most recent Primary Market Bulletin, the FCA stressed that it continues to expect listed issuers to make every effort to meet their disclosure obligations in a timely fashion. As with other regulatory obligations, the FCA is taking a practical approach, recognising that COVID-19 may create challenges in the convening and operation of disclosure committees, and, in the short term, it appreciates there may be slight delays as new processes are put in place.
In times of crisis, there may be unfounded market rumours and firms may be under a duty to correct misinformation which is circulating. Banks should seek guidance from their nominated adviser or sponsor. It is unfortunate that extreme levels of volatility create opportunities for market abuse, and it is highly likely that bank stocks will suffer. In difficult cases, legal advice may be needed on the timing and content of disclosures.
- Forward Planning
This situation is fast moving and banks will need to plan carefully and consider future developments. Banks reliant on key suppliers who are suffering undue stresses may want to consider providing short term financing to such businesses. Distressing as it is, banks may need to review and ensure the fitness for purpose of their policies for dealing with bereavement and probate cases, as well their procedures for other vulnerable customers. The FCA has disciplined firms for a failure to deal appropriately with the affairs of deceased customers, and this is likely to be an area where the FCA will be intolerant of poor practice.
- Regulatory Capital, Recovery And Resolution
The Financial Policy Committee has predicted that the impact of COVID-19 will be "sharp and large", but should be temporary. The FPC has reduced the UK Countercyclical Capital Buffer from 1% to 0% for at least twelve months, to support firms providing credit to the economy. The Bank of England’s three policy committees have launched a comprehensive package of measures to help UK businesses and households to bridge across the economic disruption that is expected from COVID-19. Additionally, the regulators have stated that they expect banks to draw down as necessary all elements of their capital and liquidity buffers.
There is a real risk of course that, despite the rigorous prudential requirements introduced after the 2008 crisis, and the measures put in place to mitigate the effects of COVID-19, not all banks will have business models that survive. Challengers are vulnerable to this, yet have the advantage of being less constrained by legacy issues as they are built on platforms post-2008.
Some may eventually recover, perhaps after a restructuring of debt and other obligations. Some will be in a resolution situation. Members of management may set up new entities in the future and seek authorisation for them. A key issue will be to ensure the fair treatment of customers in a wind-down situation. This is far from easy to balance with other wind-down and insolvency requirements but it is crucial if the FCA is expected to look favourably on future authorisation applications. It may be that we will see stronger banks acquire weaker competitors and that one outcome of COVID-19 will be greater consolidation of the banking sector.