There will be impacts to banking balance sheets due to COVID-19, but Global Finance has an optimistic perspective.
- With central banks around the globe moving quickly to pump liquidity into financial markets in an effort to counter the supply shock and stunning collapse of demand caused by the COVID-19, the creditworthiness of most major banks appeared assured, at least in the short term.
- The question remains whether a looming deep recession will reduce demand for loans, which are the banks’ bread-and-butter business, and whether banks will react by curtailing lending to avoid what one analyst has called “catching a falling knife.”
- A survey of bank analysts by Global Finance indicates that most banks are now in far better shape than they were during the 2008 financial crisis, when many required government bailouts to avoid bankruptcy.
Yes, we all remember the Great Recession. Top credit card issuers posted negative profits, we saw credit tighten, and weak players exit.
- The Federal Reserve has reacted forcefully in recent weeks, deploying many of the same tools it used in 2008: cutting interest rates to near zero and assuring banks they could use assets normally held aside as reserves—the reserve requirement was cut to zero on March 16—and establishing credit buffers to promote lending to hard-hit companies and consumers.
- The Fed also threw open the so-called discount window to any banks that need to borrow money because of a rush of deposit outflows, although in the past banks have been hesitant to take advantage of the offer to avoid sending a signal that they are distressed.
And Current Expected Credit Loss accounting forced banks to squirell away funds.
- In the US, the new method is called Current Expected Credit Losses. Under CECL, banks must estimate what their lifetime losses would be for their loan portfolios; the previous method was just-in-time accounting that separated loans into buckets and assigned reserves to each bucket depending on its riskiness.
- The CECL reserves may need to be adjusted sharply upward because of their deteriorating outlook, Kroll warns. “Banks—particularly those that lend to consumers, and who warned in the last quarter that the mix of CECL amid a recession could lead to a credit crunch—could pull back from providing liquidity to borrowers in an effort to conserve core capital,” Kroll said in a note.
- Credit stress is certain to increase because of the cash crunch in certain sectors of the economy, including airlines, hotels and restaurants, says Daniel Ahn, chief US economist at BNP Paribas. However, “it does look like banks have the capacity to absorb the shock unless things get much worse.”
And, the Stress testing everyone hated, well, they may be the saving grace.
- Longer term, with unemployment claims rocketing upward and businesses laying off employees in response to closed stores and empty hotels and airports, banks are concerned about rising defaults on such facilities as consumer loans. The two banks with the largest credit card portfolios, Citigroup and Capital One, have both seen their share price halved since the crisis began as investors worry about card defaults, which tend to track to the unemployment rate.
- Nonetheless, US banks are now considered by many analysts to be the soundest globally, thanks to the package of measures adopted after the Great Recession, including annual stress tests. Major US institutions were also required to hold high-quality liquid assets that would cover outflows over a 30-day period of crisis. Known as the liquidity coverage ratio, it differs according to the size of the bank’s assets.
- European banks took much longer than their US counterparts following the 2008–2009 downturn to reduce their stock of nonperforming loans and to adopt practices like stress testing to improve risk management.
Things will not be pretty as the year progresses due to COVID-19, but for banking, there is light at the end of the tunnel.
Overview provided by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group