By Kunal Sawhney, CEO, Kalkine Group.

The closure of various small-scale enterprises to the rising distress of most veteran conglomerates, the banking system is seeing the worst days since the financial crisis of 2008.  The unforeseen business challenges arising on the back of the global health emergency and the situations for which the enterprises didn’t have a robust alternative have given rise to a possible case of a severe downturn.

Banking in Covid-19 era

The banking and financial services sector has been deeply affected due to the collapse of businesses, disrupted operations, and an extended delay to an unsought deferral in the receivables. All these factors have collectively led to an acute hollowness within the banking system. The banks were forced to write-off a major proportion of assets from their respective books that constituted a considerable chunk of net assets. The abrupt provisioning to cover the bad assets has triggered a series of losses quarter after quarter.

From dismal to no guidance along with uncertain forward-looking statements, all the banks have recognised alarmingly high depletion of their top line and the operational profit metrics. We talk of corporate losses, the business foregone, and minimal growth rate in this period, but the retail section of the client has also contributed substantially to the net losses, if not equally.

Complicated mess

According to the Global Banking Annual Review 2020 by McKinsey & Company, the money parked by the global banks as provisions to offset the loan-based losses in the first three quarters of 2020 has already surpassed the total provisioning that was earmarked in 2019.

The losses incurred on account of loans extended to corporates and the retail clientele have spiralled beyond the limits ascertained after the world went into a collective lockdown for about two to three months. With the present touch-and-go situation in most economies, the provisioning to cover the loan losses could exceed the total amount set aside to envelop them during the 2008 global financial crisis, the New York-based global management consulting firm said.

The Covid-19 pandemic has been the biggest challenge faced by the policymakers in the recent past, said Agustín Carstens, General Manager of Bank for International Settlements, in a virtual session on the post Covid-19 banking system held in Basel on 9 December. The crisis situations are always different, but the global health calamity has tested the capabilities of financial sectors, national economies, and our health systems, Carstens opined.

He added that the Covid-19 induced shock had created a difficult task for the supervisors responsible for safeguarding the stability of the financial system.

Stress beyond normal rescue

Carstens said finding a right balance between “microprudential and the macroprudential objective of system-wide resilience” has been a tough task. Banks sitting on credit would freeze the already disrupted credit cycle, and the small-to-medium scale enterprises that need capital urgently will be left unserved, and the institutions might have to witness a notional loss.

On the other hand, lending in excess to the subprime retail borrowers or the corporates with a lower rating grade eventually hurts the financial robustness of the banks and develops a possible case of counterparty default in near future. The gradual drop in the credit requirement for the longer than expected stretch in recent months has trembled the business for the banks.

Furthermore, the lending rates hovering at historic lows across the globe have shrunk the portion of gains and the targets that were achievable in the pre-pandemic era.

However, McKinsey’s annual review suggests that the global banking industry has entered the coronavirus crisis in an adequately capitalised position and is now far more resilient as compared to the situation during the 2008 mortgage crisis.

McKinsey has added that the worldwide pandemic paints a two-stage hurdle for most banks — severe credit losses and lacklustre global recovery. As far as the discussion over the global recovery rate is concerned, the who’s who from the analysts to veteran industry experts have failed to reiterate their initial recommendations.

At the beginning of the Covid-19 crisis, experts suggested a V-shaped recovery that swiftly switched to U-shaped, then Nike’s swoosh-shaped recovery. At the moment, there is no concrete evidence or rigid outlook that can support even an inverted square root shaped recovery on a global scale.

Estimating the loss

As per estimates by McKinsey & Company, the global banks have allocated a total of $1.15 trillion in the provisions on account of loan losses for the nine months until September, much higher than the complete provisioning of 2019.

Although the governments, the World Bank, and the International Monetary Fund have announced stimulus packages as per their respective capabilities, a few in the business expect this “state of suspended animation to last”, McKinsey said in the review.

The loan loss provisions in the forthcoming period will exceed the losses recognised during the Great Recession in the base-case scenario, whereas the revenues could plunge by nearly “14 per cent from the pre-crisis trajectory by 2024” as the banks will face a profound challenge that may escalate beyond 2024.

In absolute terms, COVID-19 crisis may cost a colossal sum to the tune of $3.7 trillion to the global banking industry, the report stated. The banks stand to lose something between $1.5 trillion and $4.7 trillion in cumulative revenue between 2020 and 2024.

Going forward, McKinsey has highlighted that the banks should revise their business models to survive the uncertain period of zero per cent interest rates and economic challenges or lower demand.

Although it is difficult to predict how the state of the global banking system will be in the near future, we can hope that the banks move towards diversification and become sources of stability against the pandemic’s upheaval.