The spread of COVID-19 represents an unprecedented global health and economic shock, with the disease itself and mitigation efforts – such as social distancing measures and national lockdown measures – having a significant impact on global trade, business and livelihoods. In the immediate aftermath, the financial sector, particularly banks and NBFIs, were expected to play an important role in absorbing the shock by supplying vital credit to the corporate sector and households.
In an effort to facilitate this, central banks and governments around the world enacted a wide range of policy measures to provide greater liquidity and to ensure a steady flow of credit. An important question asked now is the potential impact of these countercyclical lending policies on the future stability of the banking system in general, and to what extent the sector-strengthened capital positions will allow them to absorb this shock without undermining the sector resilience? Also how should government policy continue to evolve to preserve financial stability? However, the uncertainty from COVID-19 will remain for the foreseeable future. Banks and capital market institutions, therefore, would have no choice but to remain hyper vigilant and rewrite their business continuity plans as circumstances change.
Fortunately for banks and their customers they can take some comfort that capital ratios were the strongest going into this crisis than at any time in the last decade.
Banks need to actively consider the immediate needs of their customers, and simultaneously the multiple short and medium-term implications for operational, financial, risk, and regulatory compliance. They have an opportunity to support market and economic activity and to facilitate a quick return to stability. If banks and capital market firms respond well to these unprecedented challenges, they will not only help governments and society, but also increase the trust and the reputation of the financial industry in the long run.
While it is reassuring to see aggressive regulatory fiscal and monetary policy responses from governments around the world, clarity on how these actions will stabilise markets and accelerate the path to normalcy is still to be seen. Since the wake of the coronavirus pandemic, both the regulators and financial institutions are now forced to steer through unchartered waters. This requires leadership of a high order. From maintaining cash and liquidity to re-adjusting operations, managing head count, cyber risks and managing operating costs. Most banks will also need to navigate through complex government support measures in order to safely weather the current crisis.
The measures introduced by the regulators to ensure adequate liquidity and access to cheap capital have helped most economies to stay afloat. The current collaboration by banks and regulators has helped the sector to maintain financial stability, as well as to manage the large number of moratoriums they have given. However the challenge going forward would be the negative impact on banks’ asset quality. Some banks globally are already seeing an eroding of asset quality and heightened credit risks. Despite the mayhem in most markets, still over 75 percent of banks’ revenues come from interest income and about 75% of the sector capital employed are depositors’ money.
How effective a sector-supported economic recovery will be however, depends on the resilience of the sector and its overall financial health. In addition, how will the COVID-19 pandemic affect banks’ loan books? Losses from loan defaults and increases in risk-weighted assets can deplete banks’ capital. The extent will depend on the spread of COVID-19 and the effectiveness of the public health response and the mitigating interventions of countries.
For example according to research, if GDP does not recover to its previous level until 2021 or 2023, $ 100 billion to $ 400 billion in common equity tier-1 capital would be wiped out in Europe, the United Kingdom, and the United States. In any scenario, banks and regulators must prepare for the next normal to be very different from that of the past ten years.
Building banks’ capital however given the global uncertainty due to unforeseen pandemics and climate changes etc., is not optional but a necessity. Fortunately better regulation of the banking systems and strengthening the tools available for supervisory agencies to oversee banks and intervene speedily in case of distress, has helped the financial sector respond effectively in most countries.
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