Pandemic Response

Regulatory Forbearance in the Age of COVID-19

Michael Stramaglia, Executive in Residence, Global Risk Institute

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Regulatory Forbearance in the Age of COVID-19


Introduction

Global financial systems play a critical role in maintaining economic resiliency in the face of systemic threats. Prudential supervisors in turn play a key role in maintaining the safety and soundness of these financial systems, largely through the promotion of effective risk management practices.

The full economic impact of the COVID-19 threat is only beginning to unfold, and still largely uncertain, reflecting the unprecedented, wide-ranging and protracted nature of this public health crisis. But this much is already clear – global financial systems have entered largely uncharted territory. While existing pandemic and business continuity plans have been constructive in helping to mount a baseline response, there is no pre-established playbook capable of addressing the full scale of COVID-19’s impact.

Navigating the current crisis therefore requires considerable professional judgement, which must be supported by a number of key elements, including; active stakeholder consultation, robust risk management information systems, effective governance and, importantly, guiding principles.

In response to this unique challenge, financial regulators have begun to implement a wide range of special policy actions. These include a number of forbearance measures, whereby regulated financial institutions have been granted various forms of explicit “relief” relative to established regulatory requirements. The fundamental economic and public policy intents underlying this regulatory relief are laudable, and these measures are well-positioned to play a decisive role in maintaining financial system resiliency.

However, it is important to recognize that any forbearance of established enterprise risk management (ERM) systems introduces the associated potential for unintended consequences. For example, these actions can create the erroneous perception that risk standards are being unduly “relaxed”, precisely at the time when they are needed the most. Dynamic risk limits may also inadvertently mask the extent to which inherent risk positions have migrated through the course of the crisis. Any resulting stakeholder misstep could undermine the overall effectiveness of these relief actions and generate collateral impacts that may be felt far beyond the course of the immediate crisis.

While guiding principles always need to play an integral role in supporting the development of risk response strategies, they are absolutely critical for mitigating any associated potential for unintended outcomes during periods of extraordinary stress.

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