The pandemic puts the resilience of banks to the test
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In his last public appearance as Governor of the Bank of England, Mark Carney said the work done to rebuild bank balance sheets after the 2008 financial crisis meant they could now be part of the solution to dealing with it. to the economic shock of the coronavirus. It had been caution with purpose and resilience with reason, he said. The question for policymakers now is whether he was right. Will the reserves built up by the banks be sufficient to protect the real economy and survive?
The true magnitude of the potential economic shock is starting to become clear. Some economists expect US gross domestic product to fall 30-40% in the second quarter; in the UK, the Office for Budget Responsibility has developed a scenario suggesting that the foreclosure could lead to the deepest economic downturn since the start of the 18th century. On a more granular level, the damage can be seen in job cuts announcements by some of the world’s major airlines.
Governments have taken unprecedented monetary and fiscal policy measures to help their economies survive lockdowns. The banking system is at the heart of this effort to keep businesses and consumers afloat. Banks have more capital and liquidity than 12 years ago. The liquidity support from central banks also mitigates some of the risks. But the resilience of banks is being tested like never before. The danger is that large credit losses could cause them to cut back on their loans when they need them most.
First quarter results from US and European lenders give an indication of the potential cost; America’s six largest lenders increased their provisions for loans in the first quarter by a combined $ 25.4 billion in April, a 350% year-over-year increase. HSBC, one of the world’s largest banks, warned last week that loan provisions could reach $ 11 billion this year, the highest since the financial crisis.
Regulators have already relaxed capital and auditing rules to allow lenders to reduce loss absorption cushions. Despite advice from UK supervisors not to recognize significant charges on soured loans – as required by new international accounting rules – the wide array of reported loan arrangements is indicative of the tightrope the banks are walking. The concern is that they could still prove to be under-capitalized to deal with the scale of the losses they will face in the months to come.
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The relaxation of the rules raises important questions for policymakers. Critics who said governments were too hard on banks in the wake of the 2008 financial crisis were wrong. As today’s crisis shows, a capital increase was absolutely necessary. If the slowdown worsens, regulators may need to consider resorting to other policy measures. The fact that so many banks needed government bailouts in 2008 spurred reform: special resolution regimes and bond bailout powers were introduced to protect taxpayers in the future. These facilities are there to be used if necessary, even if they have not been tested.
In the meantime, banks must remain the channel for granting credit to a struggling economy. When the demand for credit exceeds banks’ reasonable risk appetite, governments should provide collateral, as some have already done, for emergency loans. Existing loans should remain the business of the banks. And if banks’ capital is insufficient to absorb losses, the possibility of raising new capital should be explored. Many did so in 2008 and were able to again. It is only if these measures fail that there should be a question of a bailout or a bailout. Today’s banking system is stronger than it used to be and, for now, banks are playing their role of stress absorber rather than stress amplifier. But today’s unprecedented crisis can still push the regulatory structure to its limits.