Treatment of restructured credit exposures due to the Coronavirus (Covid-19) pandemic

Ref.: 15/8/1/3
D3/2020
To: All banks, controlling companies, branches of foreign institutions, eligible institutions and auditors of banks or controlling companies Directive issued in terms of section 6(6) of the Banks Act 94 of 1990 Matters related to the treatment of restructured credit exposures due to the Coronavirus (Covid-19) pandemic Executive summary The spread of Covid-19 is having an increasingly significant impact on global economic activity and has placed the local economy under immense strain. As
part of the measures employed to address the impact of Covid-19, government
as well as business have called upon the banking sector to continue to extend credit to sectors in need, particularly households and small businesses, and to provide relief measures to reduce the strain on these sectors in an effort to sustain the local economy and maintain financial stability. The Prudential Authority (PA) is supportive of Covid-19 relief initiatives, such as payment holidays being offered by banks in order to provide relief to certain borrowers in the retail sector in an effort to mitigate the impact of the pandemic. The PA is also cognisant of the possible effect the pandemic would have on the corporate sector. The PA has therefore decided to amend the requirements specified in Directive 7 of 2015 to provide temporary relief on the minimum capital requirements for banks, controlling companies and branches of foreign institutions (hereinafter collectively referred to as ‘banks’) relating to credit risk during this time.

1. Introduction
   1.1 The Covid-19 pandemic, which is having a significant impact on financial
   markets, global economic activity, as well as the South African economy, may invariably also impact the ability of borrowers to meet their obligations in accordance with contractual terms.
   1.2 The PA is supportive of Covid-19 related relief initiatives, such as payment
   holidays being offered by banks, in order to provide relief to certain borrowers in the retail sector in an effort to mitigate the impact of the pandemic. The PA is also cognisant of the possible effect the pandemic would have on the corporate sector. The PA also recognises that these initiatives are not driven by profit incentives, but by banks’ corporate responsibility and their application of sound risk management practices to provide relief to South Africans during this period in order to minimize the adverse economic impact.

2
Consequently, the PA has considered measures to ensure that these initiatives do not result in unintended consequences such as inappropriate higher capital requirements.
1.3 Directive 7 of 2015 (D7/2015)1 provides clarity on how banks should identify
restructured credit exposures and how these exposures should be treated for purposes of the definition of default. This Directive should be read in conjunction with D7/2015.
1.4 Paragraph 2.4 of D7/2015 states the following: “Where the loan is not in arrears
at the time of the restructure and the terms and conditions were changed in order to prevent the obligor from going into arrears, this should also be regarded as an indication of financial distress of the obligor and the restructure should be classified as a distressed restructure.”
1.5 In response to potential pressure on banks’ capital demand brought about by
the Covid-19 pandemic and the associated relief initiatives, the PA is implementing measures to provide suitable temporary relief on the minimum capital requirements for banks relating to credit risk.
1.6 These measures are intended to provide relief to banks by enabling banks to
continue to extend credit to the real economy during this period of financial stress without the need for inappropriate higher capital requirements. The intention is to assist banks to continue to serve their borrowers under difficult circumstances, thereby reducing the impact of the pandemic on the local economy. The intention of this Directive is not to promote an environment within which banks can inappropriately lower their lending standards, resulting in a build-up of credit risk in the medium to long term.
1.7 It is the PA’s intention to reinstate the requirements of D7/2015 in full afterthe
impact of Covid-19 has subsided and economic conditions have normalised. This Directive will remain in effect for a minimum period of 6 months, during which time the PA will reassess the continuation thereof and communicate in advance, the reinstatement of D7/2015 including any transitional arrangements that may apply.
2. Directive relating to treatment of Covid-19 related credit restructures
Based on the aforesaid and in accordance with the provisions of section 6(6) of the Banks Act 94 of 1990, banks are hereby directed as follows:
2.1 As from the effective date of this Directive, when a loan is being restructured,
the following must be considered:
2.1.1 Based on all reasonable and verifiable information available at the date of
restructuring of a loan, where the restructure is being considered due to Covid￾19 related factors, the bank must determine whether that loan was up to date as at 29 February 2020 and through its assessment process determine whether the loan is expected to remain in an up-to-date status subsequent to the relief period, all other factors remaining constant. These restructured loans will be classified as Covid-19 related restructures. 1 http://www.resbank.co.za/Lists/News%20and%20Publications/Attachments/6716/D7%20of%202015.pdf

3
2.1.2 If however, there is an adverse change in other actual or expected
circumstances during or after the relief period which circumstances are not expected to be temporary in nature over and above the relief provided (e.g. a mortgage debtor is retrenched or an SME or corporate enters business rescue or suffers losses that put into question its ability to repay the outstanding balance), such circumstances are indicators of distress, warranting the loan to be treated as overdue/non-performing at the time those circumstances are assessed to have changed.
2.2 Banks must ensure that only loans classified as retail (which include residential
mortgage advances, retail revolving credit, SME retail and retail other) or corporate (which include corporate, SME corporate and the various specialised lending asset classes) as per regulation 23 of the Regulations relating to Banks (Regulations), that comply with the conditions specified in 2.1.1 above would not be regarded as distressed restructures as defined in paragraph 2.4 of D7/2015. Those loans that are not reasonably expected to remain in good standing or those loans that despite the relief measures, still exhibit signs of distress, must be treated in terms of the existing requirements respectively specified in regulations 23 and 24 of the Regulations read with D7/2015 to determine the relevant minimum required amount of capital and reserve funds to be held against the bank’s credit risk exposure.
2.3 Banks are required to put in place an appropriate process of corporate
governance (including the development of an internal policy) relating to the treatment of Covid-19 related restructured loans and must be able to motivate every instance where the restructure was due to COVID-19 related factors.
2.4 When calculating the minimum required amount of capital and reserve funds
relating to credit risk under the standardised approach for credit risk respectively specified in regulations 23(6) to 23(9) of the Regulations, the risk weight assigned to the Covid-19 related restructured loans must be based on similar, but no better classification (where the classification is done in accordance with regulation 24(5)(c) of the Regulations) than before the Covid￾19 related restructure. Therefore the same risk weight assigned to the loan before the said restructure may be applied to the Covid-19 related restructured loan, as if these loans are not considered to be distressed.
2.5 When calculating the minimum required amount of capital and reserve funds
relating to credit risk under the internal ratings-based approach for credit risk respectively specified in regulations 23(10) to 23(14) of the Regulations, the probability of default (PD) assigned to Covid-19 related restructured loans must not be reduced, that is, the PD assigned to the restructured loan may be the same or higher, but not lower than the PD assigned before the restructure of that loan, as if these loans are not considered to be distressed.
2.6 In order for the PA to monitor the extent and impact of Covid-19 related
restructured loans, additional reporting requirements may be specified in writing by the PA as part of its ongoing supervisory processes.

4
3. Acknowledgement of Receipt
Kindly ensure that a copy of this Directive is made available to your institution’s external auditors. The attached acknowledgement of receipt duly completed and signed by both the chief executive officer of the institution and the said auditors should be returned to the PA at the earliest convenience of the aforementioned signatories. Kuben Naidoo Deputy Governor and CEO: Prudential Authority Date: 6 April 2020 Encl. 1 The previous directive issued was Directive 2/2020 dated 6 April 2020