CECL problems, Libor and capital relief

The week on Risk.net, June 6-12, 2020

7 days montage 120620

Banks push for capital changes as CECL provisions soar

Spike in set-asides exposes fault lines between new accounting standards and Basel rules

Twin-track solution for ‘tough legacy’ Libor falls flat

Critics deplore lack of detail in UK taskforce’s call for parallel legal fix and synthetic rate

EU urged to pass permanent market risk capital relief

Council agrees temporary changes, but ECB’s Enria wants legislators to trust supervisors

COMMENTARY: The light at the end of the tunnel (is an oncoming train)

Long-running regulatory reform efforts are set to run headfirst into Covid-related financial stress, Risk.net reports this week. Next year’s US Comprehensive Capital Analysis and Review (CCAR) stress test will cover a period more than a year after the end-2021 deadline for Libor to give way to other, less easily manipulated rates such as the US Secured Overnight Financing Rate (SOFR).

The combination will produce a serious problem for US banks: as the Covid pandemic gathered pace in March, the US Federal Reserve turned on the liquidity taps, pushing SOFR down much further than Libor. And this won’t just affect CCAR findings – it’s also a real problem for future crises, when SOFR will diverge from banks’ actual funding costs, squeezing their margins on SOFR-linked credit lines.

In Europe, meanwhile, the spate of VAR exceptions from the March crisis is feeding through into higher risk-weighted asset multipliers – constraining lending just as governments are keen for credit to start flowing again. Legislators are under pressure to give supervisors temporary or even permanent power to push down multipliers again. And Libor’s UK replacement process is making disappointingly little progress.

The arguments for delay to reform in the face of a crisis are compelling – as they were in the case of climate-related reforms. But in this case too the delay could be dangerous. Hopes of a rapid V-shaped recovery from the Covid pandemic are fading, as the disease continues to rampage across the US and grows ever more rapidly in Latin America and South Asia.

Other shocks loom on the horizon – the UK is increasingly likely to stumble by mistake into a damaging crash-out exit from the European Union once the transition period expires at the end of the year; US politics will grow steadily less calm as November’s election approaches; the knock-on effects of the Covid depression may manifest as unrest and repression in many countries around the world; even countries that are now cautiously emerging from lockdown are at risk of a second wave of infection later this year, which may be even more destructive than the first.

Any delay to reforms needs to be based on a clear and sober understanding that crisis-mode politics are the only sort of politics the world is going to see for a long time; delaying until a time of calm is a semi-permanent decision, not a short-term tactic.


Since inception on February 19, Covid beta had a standard deviation of 38%, while industry risks are typically 8% to 10% and common factor risks are lower. Los Angeles Capital Management says it has never before seen an extra market statistical factor with that kind of risk. The global quant equity firm has instituted a new factor to help it measure the sensitivities of stocks to Covid-19 and more accurately model their economic performance around the pandemic.



“If you don’t want to lose heaps of money on initial margin you deposit at central counterparties, you need to do a massive repricing” – executive at a large European clearing firm

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