COVID-19 has caused damage to global capital markets, creating severe instability and excessive volatility. The lockdown imposed to stop the spread of Covid-19 led to a sudden stop in economic activity across various sectors, affecting both businesses and employees. Companies that were dependent on direct client contacts, such as hotels and transportation, lost revenue streams, and households that work in these industries lost income.
The banking sector was also impacted but in a relatively indirect manner. While banking services can be delivered remotely and without direct client contact, the sector’s connection to the real sector as a source of payment, savings, credit, and risk management services stretches the virus’s detrimental impact to banks and other financial institutions.
How it has caused problems for banks
Initially, businesses that ceased operations and lost revenue have been unable to repay loans. Likewise, families with members who suffered loss of employment were also unable to pay off their loans due to a lack of income. This decreased revenue and increased the chance of potential losses (if repayment capacity is permanently harmed), hurting profits and bank capital. Banks can expect significant losses as a quick recovery becomes less plausible, necessitating the need for additional provisions, further eroding their strong financial position.
Furthermore, banks have been harmed because bonds and similar financial instruments have lost value, causing more losses. Open derivative positions may also result in losses due to their unpredictable nature now. Banks are also seeing an increase in credit demand, as businesses, in particular, want greater cash flow to cover their expenses even when revenues are flat or declining. Borrowers have drawn down credit lines in some situations as a result of the increased demand.
Banks are facing decreased non-interest revenues as demand for their various services declines. With lesser economic activity, there are fewer payments and transactions to be made, and fewer security issues by corporations limit fee income for investment banks.
Effect on profitability and risk management
In mature markets, the low-interest rate situation, combined with the significant impact of COVID-19, is lowering core banking profitability. As a result, financial institutions turn to commission-based income from industries such as payments and technology.
The heightened credit risk of corporate and individual clients of banks is one of the immediate repercussions. Banks must discern between transient events that will be absorbed in a short period and longer-term effects that will necessitate management and reclassification activities to continue financing the economy and promoting its recovery.
The following are the most important factors to consider:
Given the unique nature of COVID-19, the forward-looking information, particularly how new information must be incorporated into risk parameters, must be carefully examined. This may last for a shorter period of time than cyclical downturns caused by economic-financial factors; the updating of the default rates, which must take into account any exemptions given by authorities concerning only temporary events of creditworthiness expiry, the concept of the most suitable timescales for revamping the recovery rates, to take into account in the positive effects, albeit eventually in the medium term deriving from the recovery rates, which could cause deferred payments.
Change in customer relationships
Although COVID-19 may cause a real-economy crisis, its impact on the financial system and the bank-customer relationship can be viewed as a positive disruption in terms of the sector’s digitization and ability to provide exceptional customer service.
Even the most branch-focused banks are being pushed to promote the use of avenues that were never a strategic priority for them. This is a challenging period, which banks must address by displaying genuine proximity to their consumers.
Banking operators’ comprehensive grasp of their service gap, which has become more apparent than ever before thanks to COVID-19, may make them even more motivated to speed the digital transformation road through partnerships with firms involved in financial technology.
Expected long-term impacts
Low-interest rates, which are nearly zero or even lower, will be here to stay for the foreseeable future. This will undoubtedly put further strain on bank profits.
Moreover, the trend toward digitalization could accelerate even more as social distancing becomes the accepted norm and physical interactions between banks and clients become ever more expensive. This could mean more branches closing and a greater reliance on internet and phone banking.
Furthermore, the crisis will increase competition for banks from fintech companies, particularly corporations like Facebook, Google, Apple, and Amazon. These big platform providers are expected to emerge stronger from the crisis with a significant cash pile.
COVID-19 was a crisis no one was ready for. Not having mitigations for an unexpected occurrence would always cause problems and additional challenges. Analyzing the full impact on the economy and financial institutions, coming up with appropriate responses and adapting to the changing world on the road to recovery are what banks will be focusing on in the near future.
