Christopher Woolard CBE
Partner at EY, EMEIA lead financial services regulation, Chair EY Global Regulatory Network. Trustee at Which?
March 7, 2024

Open Immersive Reader

Almost a year has passed since the financial markets’ volatility was triggered by the failures of Credit Suisse and three US regional banks (Silicon Valley Bank, Signature Bank and First Republic Bank). This is commonly known as the “2023 banking turmoil.” Now is an opportune time to reflect on lessons learned from that period — namely the speed of depositor outflow, inadequacies in risk management, long-standing conduct issues, the appropriateness of the resolution toolkit — and their implications for banking supervision and regulation, and the overall impact on financial market volatility in 2024.

What are the regulators and supervisors now looking at?

Implementation of the final part of the Basel framework, Basel 3 Reforms, updated in light of the 2007–08 global financial crisis, will be key to ensuring banks are well capitalized. The Basel Committee on Banking Supervision (BCBS) maintains that these are a minimum standard and must not be rolled back to achieve short-term economic gains. Further, on 29 February 2024, the BCBS members “reaffirmed their expectation of implementing all aspects of the Basel 3 framework in full, consistently, and as soon as possible.”

More jurisdictions — including Japan and Singapore — are due to apply Basel 3.1 later this year, following countries such as Canada and China that have already so done. Other jurisdictions, including the EU and UK, are now finalizing their implementation policy, while the US is assessing feedback on their proposals. Our observations suggest that some are designing a simpler, more proportionate approach for their smaller domestic banks, as seen in Canada and the UK.

In its report on the 2023 banking turmoil, the BCBS underlined the importance of strong and effective supervision. Supervisors are increasingly acting on previous warnings and action points asked of their supervised firms, closely monitoring banks’ efforts to remediate known risk management weaknesses, together with issuing more financial penalties for failures in management, systems and controls. For 2024, we can expect a more intrusive supervisory focus on banks’ management and governance, and on risk management, including analysis of interest rate risk in the banking book (IRRBB), alongside more enhanced factors and scopes for stress test exercises.

The 2023 banking turmoil showed that central bank support is crucial during a bank run. This has driven an increased supervisory focus on banks’ liquidity risk management, asset and liability management, cash flow modeling, and the consideration of available unencumbered collateral. As regulators question the suitability of the liquidity coverage ratio (LCR) outflow assumptions to handle a contemporary bank run in an increasingly digitalized world, banks should stay vigilant to potential shortfalls in foreign currency LCRs and potential regulatory variations in the liquidity metrics, should market conditions become more volatile.

In January 2024, the European Banking Authority (EBA) Chair Campa echoed the growing regulatory concerns of the linkages between banks and the non-banking financial institutions (NBFIs), including hedge funds, private equity and cryptocurrencies. He noted that the NBFI sector is growing faster than the banking sector and is becoming a major partner in the financing of the real economy.

All eyes will be on two reports due out later this year. The first is from the Financial Stability Board (FSB) on NBFIs, potentially providing policy options for non-bank financial leverage. The other is from the Bank of England (BoE) on its system-wide exploratory scenario (SWES) exercise, examining the risks, behaviors and market dynamics of banks and NBFIs during stressed financial market conditions.

In terms of the international resolution framework for global systemically important banks (G-SIBs), the FSB’s preliminary review of the 2023 banking turmoil remains apt. However, regulators continue to deliberate whether to expand the level of depositor protection, the adequacy of depositor protection schemes and the potential for these protection schemes to be used as “bridge” financing for ailing banks. On resolution, some supervisors are starting to extend their regimes to ensure the suitability of resolution strategies for smaller to medium-sized banks and other financial entities such as insurers.

What does this mean for banks?

Banks need to maintain vigilance to the volatility in the financial market, due to ongoing inflationary pressures and escalating geopolitical risks tied to the persisting war in Ukraine, the conflict in the Middle East, and over half the democratic world holding elections in 2024. These may drive policymakers to concentrate on short-term fixes rather than longer-term strategy. Banks should broaden their methods for identifying new or emerging political risks within the countries they operate in, including assessing societal concerns, and incorporate these within their risk frameworks and scenario planning. Banks should be revisiting their business models to assess whether they need to be updated to better reflect digitalization, their exposures to NBFIs and risks from outsourcing to critical third parties. Further, banks should be using their own stress testing to assess their financial resilience in their capital and liquidity planning against these risks.

In addition, due to vulnerabilities arising from a combined strain of recent interest rate increases, property value declines, and occupancy rates not recovering to pre-pandemic levels, banks’ exposures to the commercial real estate (CRE) market may find themselves under regulatory scrutiny. We envisage that supervisors will be looking at banks’ early identification of borrowers that may struggle to service debt and the implications this may have on banks’ loan books, and what assistance they can offer to customers in managing or restructuring their debt.

It would be wise for banks to reflect on the 2023 banking turmoil and incorporate lessons learned into their crisis and resolution planning, such as undertaking simulation exercises to assess how they would respond to an adverse social media reaction or a bank run, including ensuring they have a communication plan for key stakeholders. Noting regulatory consideration on enhancing banks’ emergency liquidity planning, they may already wish to consider placing greater reserves with their central bank, such as in the form of available unencumbered collateral.

Furthermore, banks need to focus on delivering pre-agreed supervisory actions and the remediations of identified issues, in line with regulatory requirements and supervisory expectations.

Summary

While the outlook for the financial market remains uncertain in 2024, it is imperative for banks and their supervisors to fully comprehend the plethora of risks that they may face. This understanding should underpin the development of a comprehensive strategy and adequate plans to manage these risks effectively, thereby ensuring a timely and suitable response when needed.