The (real) opportunities for the banking industry post-COVID-19
Unlike previous crises, the COVID-19 crisis is not a banking crisis. It’s a crisis of the real economy, and this means that the disruption is somewhat different from previous crashes over the decades. Whilst we shouldn’t be complacent about the possible effects on the banking industry, the predictions of experts point to the banking industry’s particular resilience and the possibility that the future might not be as bleak as we currently fear.
This is one of the main conclusions of the latest report on global banking from the consultancy firm McKinsey. Far from being overly optimistic, the analysis simply takes into consideration recent changes in the industry and contextualises the growth expectations before the pandemic against the banking industry’s response since the lockdown measures were lifted.
It’s plain to see (and this is very relevant to us at GDS Modellica) that there will be severe credit losses, which we will start seeing towards the end of 2021. However, despite this, predictions suggest that virtually all banking systems will survive. The bigger challenges will come later and could well extend into 2025. The report estimates an accumulated figure of anything between $1.5 trillion and $4.7 trillion in lost revenue between 2020 and 2024, with a base-case scenario of $3.7 trillion. Is this a lot? Yes. Is it serious? Definitely. It represents a drop of around 14%. In fact, to put this into context, $3.7 trillion is the equivalent of more than half a year of the expected industry revenues before the pandemic.
Even in February, no one could have foreseen that it was possible to stop entire economies, and in some instances, up to two or three times. Each lockdown left tens of millions of people without a job or stable income, without mentioning the huge losses suffered by businesses. It goes without saying that all these people and businesses are customers of the banking industry, and it’s entirely predictable that there will be defaults in a few months’ time.
Global banks have provisioned $1.15 trillion for loan losses through to the third quarter of 2020, which is much more than they did for the whole of 2019. It’s not a silver bullet, but it will certainly be a significant help when the moratoriums and government support end. In the eyes of the report’s authors, the industry has enough capital to withstand the impending shock.
In the second phase, the deeper impact will be felt when these effects transfer from balance sheets to income statements. But if we analyse things objectively, all this could just simply be an acceleration of the behavioural changes that were already on their way. Banks may well recognise the need to be more cautious with risk, and there could be a change in strategy to see refinancing as an opportunity, seeing government support not as a crutch but as a way to redefine their relationship with customers.
Ultimately, it will be the only way to face up to the enormous challenges ahead. “Some will need to rebuild capital to fortify themselves”, says the report, which also claims that “zero percent interest rates are here to stay and will reduce net interest margins”. This, in turn, will push established operators to “rethink their risk-intermediation-based business models”, while “the trade-off between rebuilding capital and paying dividends will be stark, and deteriorating ratings of borrowers will lead to inflation of risk-weighted assets”. All of this represents more pressure for the industry, but it’s still a setting in which it is possible to operate, navigate and establish some clear ways forward.
One of these ways forward, as if we hadn’t mentioned it enough, is to accelerate the shift to digital banking. This is not just a fad; many customers are already making this shift and reconfiguring the branch network is not just a cost-saving measure anymore. Since demand has softened, it’s also a logical response to changes in the market. With customers using cash and cheques much less and showing a growing interest in digital banking, the opportunity is there to use new ideas to significantly improve productivity and capital accuracy.
To achieve this, banks will need to educate customers about their attractive propositions, and this is something that they had already started to do. Before the pandemic, banks had already seen up to 25% less branch use. If the market demands it and the circumstances are right, the intelligent thing to do is take advantage of the situation to generate streams of efficiency where before there was organisational inflexibility.
The report provides a particularly important example of this previous point: “One bank developed an algorithm that considered the ways branch customers accessed seven core products. It found that 15% of branches could be closed while still maintaining a high bar on serving all customers, retaining 97% of network revenue, and raising annual profits by $150 million.”
Looking at the long term, the report recommends focusing on corporate positioning as a way to assure prosperity. The report asserts that, as well as embedding speed and agility and reinventing their business models, banks need to “bring purpose to the fore, especially environmental, social and governance issues”, with a special emphasis on climate change. This is something that the industry is approaching through the building of climate-finance businesses, something which is “the logical outcome of their commitments to the Paris Agreement, and it fulfils a critical part of their contract with society”.