Question

What are the risk(s) for the banks during the Covid 19 crisis? Please provide evidence and reasoning.

Answer 1

GLOBAL COVID-19 PANDEMIC CURRENTLY CAUSING SIGNIFICANT MARKET DISRUPTIONS

External shock hits a fragile global economy – limited headroom for responses of central banks

Containment is the best solution for society, but fatal for the economy – the longer the pandemic persists, potentially the deeper the recession

Liquidity shock due to decline in sales already impacting SMEs and specific sub-industries

Disruption of supply chains and production stops could soon potentially lead to more widespread liquidity shortages in many industries

COVID-19: FIRST EFFECTS IN THE BANKING SECTOR

Corporate customers draw their undrawn credit facilities to increase liquidity buffer

Low-rate environment here to stay further limiting financial flexibility of European banks

First development banks extend support measures for SMEs/ corporates

Increasing pressure to make decisions in dealing with covenant breaches and unprofitable customers

RISKS FOR BANKS IN CASE OF A LONG-TERM PANDEMIC

Income decreases sharply

• Extremely low interest rates due to further central bank interventions and "flight to safety" in the markets

• Economic uncertainty and slumps in financial results reduce demand/fees from investment loans

• Slump in M&A and ECM fees and reduced issuing activity in DCM (plus pressure on margins)

• Decline in custody, administration and management fees in billing models based on asset values

COVENANT BREACHES, PAYMENT DELAYS AND DEFAULTS ARE INCREASING

· Financial companies

· Commercial real estate

· Transport Finance (especially Aviation, Shipping, Rail)

· Business customers and SMEs

· Corporate clients

Uncertainty regarding fiscal and monetary policy responses and other policy measures (e.g. further isolation) persists

INITIAL ASSESSMENT OF POSSIBLE PRESSURE POINTS

Potential advantages through "true" global diversification (asset, funding)

• Accelerated erosion of the income base (e.g. investment banking/ corporate

finance, asset management, transaction banking)

• Significant exposures in asset-based finance, potentially short-term

(Shipping, Aviation) but also long-term effects (e.g. Real Estate)

• Corporate customers – delayed effects possible

• Transport or logistics exposure with potentially early effects – especially for

Shipping portfolios , early P&L effects possible – decline of new business

• Strong dependence on wholesale funding as a "swing factor" in stability

• Risk of loss in investment portfolio at banks with deposit surplus

• Direct impact in the business customer/ SME segment and, at a later stage,

In corporate segment (larger institutions)

• For captives, potentially strong pressure on funding ability as rating

Determined by manufacturing business

• (Abrupt) collapse of new business possible

• Diversified loan portfolios and funding initially stabilizing – full transparency

on developments in the credit market required

• Provisioning levels and origination of recent years may now cause turmoil

KEY ISSUES

Branch operations

• Your branches may not be set up to support “social distancing” guidelines
• You may have excess real estate capacity after temporarily reducing your branch footprint.

ATM operations

• Advanced kiosks may be able to take on some work that is currently performed by tellers
• It may get harder to service ATMs (e.g. reload with cash) as disruption spreads.

Contact operations

• Your contact center may not be prepared to handle a surge in volume, if your efforts to reduce branch traffic are successful.
• One of your contact centers may become contaminated.

Back office operation

• You may have difficulty maintaining SLAs and controls as activity increases.

Third-party support

• You could face increased operational risk when using external service providers, given the global scope of the pandemic.

Controls and policies.

• As you adjust your work processes, there could be new blind spots for additional fraud and execution risk, especially with regard to supervisory functions and compliance operations.

Employee compensation and benefits

• Your current staffing level and compensation model may not be appropriate given that some fee revenue has declined sharply and some workloads may shift from branches to contact centers.

BANKS SHOULD FOCUS PRIMARILY ON THE SHORT-TERM IMPACTS IN FOUR KEY AREAS OF RETAIL AND COMMERCIAL BANKING

• Credit Management

• Revenue Compression

• Customer Service and Advice Provision

• Operating Model Adjustments and Cost Control