On August 3, 2020, the Federal Financial Institutions Examination Council1 (FFIEC) issued a new joint statement of principles for banks to consider while working with their loan customers as the end of COVID-19 initial loan accommodation periods wind down. Bank regulatory agencies have previously encouraged financial institutions to work closely with borrowers to enter into loan accommodations to mitigate the adverse impact of the global pandemic.
What Happened
The latest FFIEC guidance reiterates that banks should continue to provide accommodations that are grounded in a thorough understanding of the borrower’s credit risk and cash flow pressure, while still complying with applicable law and regulation. In particular, the FFIEC emphasizes that banks should adhere to the following key principles when assessing accommodations for both commercial and retain loans:
Prudent Risk Management
Financial institutions must continue to assess the effect of loan accommodations on an ongoing basis so that they are able to identify potential risk of loss. In particular, banks should continually identify, measure and monitor credit risk associated with loans and ensure that management is fully informed about the scope of accommodations which are being granted. We encourage boards of directors to take a close and focused interest in management’s presentation of a bank’s credit risk profile, as it may change in light of these credit accommodations.
Well-Structured and Sustainable Accommodations
Banks are encouraged to consider additional loan accommodations to mitigate losses, even after an initial accommodation is expiring. That said, such an accommodation must be well designed and well structured, closely reviewed to ensure that it is consistent with the risk characteristics posed by the credit, and evaluated for the impact the COVID-19 crisis has had on the borrower.
Consumer Protection
Banks should take into account the financial impact accommodations can have on customers, including the benefit from customers avoiding delinquencies or other adverse credit consequences. This means that banks should engage directly with their customers to timely apprise them of available credit options, provide clear disclosures so customers can make prudent choices, and ensure that all the available credit options comply with applicable law, including fair lending regulation.
Accounting and Regulatory Reporting
Financial institutions must follow applicable regulatory and accounting reporting requirements for all loan modifications. This, of course, includes maintaining sufficient allowances for loan and lease losses and considering the effect of COVID-19 on all loan loss estimates. The FFIEC reminds banks that the various bank regulatory agencies have issued an important interagency statement on relief from accounting for modified loans as troubled debt restructurings, and that banks must ensure that any subsequent modifications adhere to this regulatory guidance.
Internal Control Systems
Finally, the FFIEC reminds banks that prudent risk management of loan accommodations includes credit risk review, operational risk assessment, quality assurance and internal audit functions that are appropriate for each bank’s size and level of complexity and risk. All of these internal control functions must be prudently tested to ensure that credit accommodations are processed in a fair and consistent manner, bank staff are qualified and able to handle all accommodations, and risk ratings for credits are adequately supported.
Why It Matters
Bank regulatory agencies continue to lay a firm foundation for allowing financial institutions to provide additional credit accommodations within a safe and sound risk-based framework. As the first regulatory cycles begin to take into account loan accommodations made during the COVID-19 pandemic, banks are encouraged to continue making sure that all of their loan accommodations are well documented and to follow closely the prudent risk practices that the FFIEC has provided in this latest guidance.
1 The FFIEC is composed of a member of the Board of Governors of the Federal Reserve System, the Chairman of the FDIC, the Comptroller of the Currency, the Director of the Consumer Financial Protection Bureau and the chairman of the State Liaison Committee.