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The Effect of Coronavirus on the Banking Ecosystem

The coronavirus crisis has led to a disruption in the economy. The path ahead is risky, and epidemiological uncertainty drives this risk. There is a unique blend of the shocks to both demand and supply, thereby affecting the macroeconomy. Currently, the United States and Europe are the prime epicenters of the crisis. Unfortunately for Italy, high government debt and years of low growth are colliding with the spread of the disease in the elderly. France and Spain also face similar prospects, and so do many states in the US and countries in Asia. Characteristics specific to the US economy will make it susceptible to the effects of the virus, although the economy was strong before the virus entered the US. Many businesses and households are vulnerable since they have a high debt to repay.

That said, the virus could impair the likelihood of market illiquidity. The European Central Bank and Federal Banks have reduced the rates to zero. Since many banks provided their customers with low interest rates, they are facing trouble during the crisis. According to the latest data, economists believe that several regions across the globe are in a recession. To address the situation, countries must work towards public-private coordination and global action. Banks will play a significant role in this since they work as stabilizers for the economies, employees and customers. Credit extension, cash and deposit services, and payment facilitation are essential services that banks must provide. Banks are also market makers, i.e. they deal with assets and securities as well.

We will look at some actions that banks must take beyond what a crisis response checklist or business continuity plan suggests. Financial institutions must plan their responses for an acute period that spans their entire footprint. They must keep the stakeholders in mind, and not only work towards the constrained circumstances that a business continuity plan usually addresses. Banks should also begin to stress test their financials and capabilities. They can lay the groundwork so they can identify any implications in the long-term to ensure a smooth transition between the present and future.

Immediate Response

Most banks have taken serious action in response to the coronavirus. They are working towards:

• Travel reduction
• Establish a central task force
• Segregate teams
• Suspend large gatherings
• Improve interaction policies with vendors
• Make arrangement for teleworking

Apart from this, banks must also prioritize some measures tailored to overcome both market and biological stresses to reduce the effect on global markets.

To Ensure Sustainability of the Workforce

Most firms have taken proactive measures to protect their employees. These include the restriction of travel and other prevention policies to offer employees alternative methods to work remotely. Having said that, health measures to contain the spread of the virus will take months and not days or weeks. Therefore, banks must set up sustainable measures. They must ensure they get the best out of their employees while they sustain their financial and mental well-being. They should also consider contract and contingent workers who will be severely impacted.

Banks must adopt a carefully segmented approach to manage their workforce since they provide essential services to communities and customers. Further, they must pay attention to those employees who provide customer or infrastructure services. These services include call-center support, branch employees, employees in the treasury function, trade and sales personnel, and custodial and facilities staff. There must be trading activities for the market to function. Banks cannot execute trade activities remotely due to compliance and technology requirements. Banks have taken actions to invoke the business continuity plan for some parts of the sales teams. Unfortunately, not all banks have the capacity to sustain or support the split-team model. Therefore, banks must consider alternative approaches if the crisis extends. Financial institutions must test backup plans and maintain them in case the disease spreads across sites. They should establish triggers to invoke the plan.

Banks must review the practices, controls and policies in place for those employees who can work remotely. They must tailor these policies to the new environment. Banks must also train internal technical support and employee relations to accommodate any level of requests. Institutions must ensure they have appropriate controls in place in every workplace setting. The policies should consider the risk appetite as well. Some key considerations include fraud, data security, privacy and cybersecurity. They must ensure that they can protect customer information. Managers should update the disaster recovery and business continuity plans to cater to these new conditions.

Address the Needs of Retail Customers

Banks must continue to provide essential services even during these times. They must continue the operations of branches and ATMs with the required safeguards. They must, however, encourage people to use remote services. This approach will consider the preferences and needs across all consumer segments, including the older generation since they are more vulnerable to the virus. Some customers may still prefer in-person services. Financial institutions must monitor the demand and work to adjust capacity and minimize risks. Some financial institutions are adopting consumer-friendly yet rigorous approaches to contain the disease. This enables them to inspire customers’ confidence in the system and safeguard health. Some examples of these measures are alternatives to signoffs, remote advisory capabilities and deep cleaning of ATMs and branches.

Banks must still motivate customers to use virtual channels. To do this, banks can launch safety-oriented and positive messages to coax the customers to reduce their reliance on branches for digital services. They must also provide online tutorials to improve their support functions. Banks and other financial institutions can identify some key functionalities and enhance their digital offerings. For example, they can simplify the process to reset passwords or increase the number of online activities.

Unfortunately, risks of fraud and loss of information are likely. Threat actors and opportunists will take the chance to exploit vulnerabilities and confusion that stems from the changes in the ways banks serve their customers. Banks must ensure they hire risk professionals to run control tests. They also need to adjust their risk appetite. Customer education is a must if the banking system is to continue to flourish remotely.

Support Businesses and Households with Credit

The current safety measures imposed by governments will negatively affect most businesses and households. For instance, over 75% of the workers in the US claim they live paycheck to paycheck. Unfortunately, some businesses pay their workers by the hour, and the financial impact of quarantine affects these workers the most. The stress will increase for those who are in debt. These individuals will need further support from banks and other financial institutions to support the liquidity needs. The impact will vary among businesses based on the company or sector. The disruptions in demand and supply severely affect sectors like oil and gas, travel and tourism, automotive, entertainment and healthcare industries. Smaller businesses that cannot work remotely are more affected.

Banks must identify the sectors and customers most affected and improve the support they offer. Some banks are considering relaxed payment schedules. They are also increasing credit lines for available loans. To do this, banks must engage with clients to understand their situation. They must segment the portfolio based on the expected needs of the client and develop a view about the support measures they can offer. If banks continue to support their clients during these troubled times, they can improve customer relationships and reaffirm their role as the key enablers of the global economy.

Since regulators understand the challenge, they are relaxing rules for banks. They can operate below the required level of capital under the Pillar 2 in BASEL. This will help banks support businesses and households during these trying times.

Stress Testing

This pandemic will affect the performance of a financial institution across various dimensions including losses, expenses, interest, revenue, and fees. These variances will be significant depending on the customer segment and the effect of the scenario on the global economy. The exact impact of this pandemic on the global economy is uncertain. That being said, experts anticipate the following:

Fee Income will Fall

The slowdown in investment-banking activities, lower spending in retail businesses and fewer assets under the asset-management division will drive this change in the economy. Some trading and sales businesses are an exception since the volume of fixed-income flows will increase. This volatility will increase the bid-ask spread, thereby increasing potential market gains.

Compressed Net Interest Margins

These will remain compressed since rates are still low and will continue to remain low for the near future. The losses in these portfolios will offset any increase in borrowing volumes.

Elevated Credit Losses Across Sectors

This will happen in certain retail segments and across small businesses. Within commercial banking, the industries hit the hardest because of the economic changes are entertainment, tourism and travel industries. It may be a challenge to lend to the oil and gas companies since the outcome of these companies is dependent on the geographical factors that affect the price and production of oil.

Increase Costs Due to Remote Working

Since the cost to set up remote working spaces is high, it can lead to lost wages paid to contingent staff.

Banks must apply testing tools to understand the impact of their methods and policies under the evolving scenario. They must also monitor the processes to reduce the possibility of fraud. They can use the existing stress testing frameworks to do this. Banks must also maintain a scenario-based view on the expected impact of the virus across various businesses. While doing this, they must keep the following points in mind:

Iterate and Prioritize

This cannot be a hypothetical exercise. The results of any stress test will have an implication on any decision the banks make in real time. Hence, they must identify the industries that need most help. They can do this when they monitor and analyze data for early warnings. This will enable them to build a better view of the economy.

Identify Worst-Impact Scenarios

To do this, banks must perform reserve tests. Regulatory and supplemental stress testing lay out specific hypothetical scenarios that banks must consider when they assess potential impact. Banks must find ways to support markets and borrowers during these times.

Examine Performance Assumptions

Banks will include some assumptions around performance in their existing models. Since the current situation is unprecedented, these assumptions will not hold. Due to the current situation, banks have broken most assumptions used in treasury models. Banks must also remember that currency collection assumption will not hold. These assumptions are dependent on whether banks will collect now.

Consider Near-Term Actions

Most financial institutions have worked effectively to contain the spread of the virus to protect the health of their employees and customers. If they continue to follow these measures for several months, the implications will be non-trivial. Banks must, therefore, work to understand these implications better.

As payment facilitators, credit grantors and deposit gatherers, banks must play a vital role to enable the function of the economy. A bank is not a commercial enterprise but provides important services to communities and individuals. Therefore, the health of these institutions is critical to the economy. The systemic risks in banks led to the financial crisis in 2008. The current financial crisis originated outside the banking system. Therefore, banks must work as systemic stabilizers. This means they must think carefully about the short or medium-term options they provide businesses and customers.

When they do this, bank leaders must remember that this crisis will reinforce many existing trends. As banks settle into their new roles and routines over the next few weeks and months, they must perform tests to see what works for them. They also must draw implications for their organizational, culture, HR and governance transformations. They must also remember that customer expectations and routines will shift in meaningful proportions in terms of proactive care, communication and digital adaptation.

Banks must test their operational resilience since it remains critical with the mounting risks of geopolitical, societal and pandemic tensions. Therefore, banks should use the current situation to enable digital transformation. They must also improve their financial and operational resiliency to cater to any future pandemics or issues.