Quarterly update on financial services regulatory developments
Christopher Woolard CBE
Partner at EY, EMEIA lead financial services regulation,
Chair EY Global Regulatory Network. Trustee at Which?
The banking sector has so far been resilient to the geopolitical shock caused by Russia’s invasion of Ukraine and wider economic circumstances. But downside risks are increasing, and regulators are concerned about the repercussions of the macroeconomic environment and financial market dynamics for asset quality and banks’ funding. Therefore, regulators are revisiting and adapting their supervisory priorities.
This quarterly update highlights key changes in supervisory priorities across jurisdictions in 4Q22 that may lead to increased regulatory requirements for FIs.
1. Basel Committee on Banking Supervision (BCBS) prioritizes work on emerging risks and vulnerabilities, digitalization, climate-related financial risks, and Basel III implementation. On 16 December 2022 the BCBS published its strategic priorities for 2023/24. Key themes include:
• Emerging risks and horizon scanning: BCBS will focus on bank and supervisory implications of risks related to inflation, emerging market economies, and cross-border booking models and will continue to assess the robustness and suitability of banks’ credit risk models.
• Digitalization of finance: BCBS will publish a report covering the emergence of new entrants and suppliers in the banking system, the use of artificial intelligence and machine learning, big data and governance arrangements, and banking as a service. With regards to crypto-asset markets, BCBS will assess the role of banks as stablecoin issuers, custodians of crypto-assets and broader potential channels of interconnections with the crypto-asset ecosystem. It also plans to review by the end of 2023 the treatment of permissionless blockchains with additional safeguards and the criteria to identify stablecoins eligible for “Group 1b” prudential treatment, including the appropriate composition of reserve assets and the effectiveness of statistical tests.
• Climate-related financial risks: BCBS will consider whether potential regulatory measures to address climate-related financial risks are needed. It will monitor the implementation of its principles for the effective management and supervision of climate-related financial risks published earlier in 2022 and discuss potential complementary work related to banks’ transition planning and use of climate scenario analyses. On disclosure, BCBS will seek to complement International Sustainability Standards Board’s (ISSB) initiatives by developing a set of bank-specific “Pillar 3” disclosure requirements.
• Monitoring and review of existing standards and guidance: Targeted initiatives include an update to the core principles for effective banking supervision, developing guidance with regards to banks’ interconnections with non-bank financial intermediation (NBFI), an update of supervisory principles on banks’ outsourcing practices and reliance on third- and fourth-party service providers, and a review of the shock scenarios developed in its standard on interest rate risk in the banking book.
• Implementation and evaluation of Basel III: The full, timely and consistent implementation of Basel III remains a high priority for the BCBS, which will also include the evaluation of the impact and efficacy of Basel III in the medium term.
2. The European Central Bank (ECB) wants banks to address immediate risks stemming from current macroeconomic shocks. On 12 December 2022 ECB published the Single Supervisory Mechanism (SSM) supervisory priorities for 2023-2025. The medium-term strategy aims to strengthen the resilience of the European banking sector to immediate macro-financial and geopolitical shocks and ensures banks address the structural vulnerabilities identified last year, as these remain highly relevant. Key changes include:
• Credit risk to remain on ECB’s agenda: Higher interest rates, a recessionary growth outlook and an increase in the cost of living may challenge the debt-servicing capacity of borrowers. The ECB will focus more on tackling deficiencies in banks’ credit risk management frameworks than on quantitative targets (e.g., reduction of non-performing assets). It will review banks’ loan origination and monitoring practices and review the IFRS 9 provisioning framework to ensure a fair and timely recognition of expected credit losses in banks’ balance sheets.
• Funding risks to be mitigated: The increase in inflation and a subsequent tightening of monetary policies (e.g., adjustments to the third series of targeted longer-term refinancing operation (TLTRO III) terms) in advanced economies have increased banks’ central bank funding costs. Banks may face funding challenges when turning to wholesale markets as these are becoming more expensive and investors’ risk appetite is decreasing. Therefore, ECB is prioritizing funding risk and will review TLTRO III exit strategies of banks that have a material reliance on this funding source. Banks will also need to address weaker liquidity and funding risk management practices.
• Deficiencies in risk data aggregation and reporting to be addressed: As banks have insufficiently complied with the BCBS’ principles for effective risk data aggregation and risk reporting banks will need to address their weak oversight of management bodies, fragmented and non-harmonized IT landscapes, low capacities for aggregating data at group level, and the limited scope of their remediation plans.
3. The UK's Edinburgh Reforms aim to remove some regulatory burdens on financial institutions. On 9 December 2022, the UK government announced a package of reforms to support ‘an open, sustainable, technologically advanced financial services sector that is globally competitive’. About 30 proposals can be categorized to meet four key goals:
Create a competitive marketplace by promoting the effective use of capital:
• The UK aims to build a smarter financial services framework, which aims to repeal retained EU law (REUL) and replace it with a new framework tailored for the UK. For example, the payments regulation reform will remove unnecessary customer information requirements related to bank accounts imposed by EU’s Payment Accounts Regulations.
• The reforms will also update banking regulation such as the UK ring-fencing regime, where the government will bring forward secondary legislation in 2023 to improve the functionality of the regime. For 1Q23 there are plans to align ring-fencing and resolution regimes, potentially rewarding ring-fenced banks with credible resolution strategies.
• Wholesale markets reforms such as the removal of EU requirements related to MiFID reporting rules or the reduction of settlement times for securities transactions are planned, while reforms to Solvency II and plans to enhance the investment freedoms of other long-term capital aim to unlock investments to drive growth in the UK.
Become a world leader in sustainable finance: The UK will update its Green Finance Strategy in 2023 and will consult on bringing ESG ratings providers into the regulatory perimeter.
Promote technology and innovation: The launch of a financial market infrastructure sandbox in 2023 will enable firms to test new technology such as distributed ledger technology. The UK is establishing a regulatory regime for crypto-assets and aims to bring a broader range of investment-related crypto-asset activities, beyond stablecoins, into the regulatory perimeter. There are also plans to consult on a UK central bank digital currency.
Focus on consumers and businesses: The fragmented and complex UK consumer credit regime will be modernized with regards to consumer lending and protection. UK will also foster digitalization and increase access to credit through innovative credit products.
4. US Office of the Comptroller of the Currency (OCC). On 6 October 2022, the OCC released its bank supervision operating plan for fiscal year 2023-27. The plan outlines 13 supervisory focus areas for national banks of all sizes and reflect priorities of state and other federal bank regulators. As such, the OCC list may also serve as a guide for non-OCC institutions.
• The OCC will focus on strategic and operational planning and assess banks’ financial positions.
• Operational risk from cybersecurity threats, control breakdowns, and risk management gaps remain a focus including the governance of banks’ third-party relationships.
• Supervision will focus on the effectiveness of risk management systems relative to the complexity of business models and ensure banks are embedding climate-related financial risks into these systems.
• As market and external conditions are changing the credit risk environment rapidly, banks’ stress testing of adverse economic scenarios will be evaluated. Risk-based examination will focus on new products, areas of highest growth, portfolios that represent concentrations, and fair lending risks.
• Banks will have to appropriately manage liquidity and interest rate risk.
• Finally, the Community Reinvestment Act (CRA) is being modernized and may become effective during FY 2023.
Disclaimer: The views reflected in this article are the author’s and do not necessarily reflect the views of the global EY organization or its member firms.
Partner at EY, EMEIA lead financial services regulation, Chair EY Global Regulatory Network. Trustee at Which?
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