10. August 2020, 18:21
In order to reduce the impact of COVID-19 on the financial system, many countries are switching their government subsidy measures to granting private loans. This largely shifts the responsibility of keeping the economy going in times of COVID-19 to private lenders. According to a recent study by the consulting firm Accenture, European banks are assuming that they will have to raise up to 415 billion euros in the current year to cover loan losses caused by the pandemic.
The study “How Banks Can Prepare for the Looming Credit Crisis” found that banks around the world will set aside up to 2.4 percent of their existing loans to cover losses from unpaid loans. That is almost twice as much as the institutions had to write off during the global financial crisis in 2008.
“Our banks play a crucial role in cushioning the economic effects of the global pandemic and in ensuring a rapid recovery of private households and small businesses,” said Markus Hamprecht, Head of Financial Services in DACH. “When the state aid programs expire, the institutions will have to reserve more capital to protect against loan defaults. In order to align their strategies for credit management accordingly, banks need a forward-looking and data-supported view of the current credit risk, whereby the long-term view of the customer should be in the foreground. “
Banks need a lot of money to cover potential credit losses
Last year, European banks made 80 billion euros available to cover potential credit losses. Accenture estimates that financial institutions will need an additional 265 to 335 billion euros in 2020 to potentially write off non-performing loans. For example, banks in the US can write off up to $ 320 billion in 2020, an increase of $ 265 billion from 2019. Chinese banks can take write-offs of up to $ 360 billion over the same period, up from $ 190 billion from 2019.
In an increasingly leveraged economy, banks are faced with the task of managing their loan portfolios and, at the same time, making decisions about new lending. The study also notes that this could lead to record levels of public and private debt around the world. Analysts predict this could reach as much as $ 200 trillion by the end of 2020. This can seriously jeopardize the repayment ability of businesses and households.
Big banks were in a stable position before COVID-19
At the beginning of the pandemic, numerous banks were financially so well positioned that they were able to absorb significant credit losses. According to an analysis by Accenture, the largest banks in the world held capital reserves that were well above the requirements of the regulators. The study also found that the five largest US banks were able to provide reserves amounting to 60 billion US dollars in the first half of the year. European banks deposited nearly $ 18 billion in the first quarter of 2020. These provisions can be called as soon as government subsidies run out and customers are in default.
“The banks will have to operate carefully in order to find the right balance between saving their customers financially and protecting their own profitability and solvency,” Hamprecht stated. “This demands difficult decisions between loan extensions that help financially viable customers and delaying an inevitable bankruptcy,” said Hamprecht. “Banks who now act with foresight can use the data and analysis skills they have acquired to date to develop operational strategies for credit management that are tailored to individual industries and regions.”
Temporary weak points in banks’ credit management
In a climate where bad debts have no impact on consumer creditworthiness and where a company’s real economic position is unclear due to short-time working and wage protection regulations, banks can take a data-driven approach to managing their loan portfolio.
In the past ten years, banks’ credit management has shrunk to a minimum. In order to cope with rising failure rates, many of them now have to expand their resources to a degree that goes well beyond the traditional capacities in this area. But thanks to investments in digital technologies made during this time, bank employees can now develop individual solutions for their customers in order to bridge financial bottlenecks.
This study shows how banks can strengthen their credit management skills and prepare their business for the challenges ahead.
- Working with regulators to avoid or minimize unintended consequences, such as the thinning of new loans
- Introduce clear guidelines and transparency regarding loan repayment
- Ensuring fair treatment of borrowers with clear rules for assessing the creditworthiness of customers
- Balance sheet risk management while advising companies and private households on how to cope with financial crisis situations
“It is difficult for banks to withdraw from the current lending business – even if it seems tempting to them. The demand for credit will inevitably increase and must be met. If the banks withdraw, the lending business will be serviced by other market participants, ”explains Hamprecht. “The biggest competitors are not just FinTechs and BigTechs, but increasingly also large, financially strong companies that offer financing options for their products and services. If banks try to drastically reduce the supply of credit, they risk losing their customers. “