“Higher levels of credit risk, along with potential market adjustments due to abrupt reassessment of risk premia and sharp repricings, can impair banks’ capital ratios. This is a key focus for bank supervisors,” he says. To guard against such risks, supervisors have directed banks to obtain more forward-looking credit risk estimates – quantified more frequently, with less reliance on external ratings, which only reflect historical data and often do not capture significant increases in credit risk quickly enough.
Indeed, the substantial and potentially longer-duration effects of the pandemic on economies, markets and participants require banks to be more vigilant and forward-looking throughout the credit risk management cycle, all the while also monitoring for and addressing wider market and liquidity risks.
In December, the ECB outlined expectations through a ‘Dear CEO’ letter directing ‘significant institutions’ to assess credit risk more actively, using quantitative calculations at point-in-time versus through the cycle, and stressed the role of governance and board responsibility for management of all risks, including credit risk.