Citing lessons learnt during the 2008/2009 global financial crisis, leading management consulting firm, McKinsey & Company, has said that banks globally have no choice but to rebuild their capital if they are to effectively support post- COVID-19 economic recovery.
The firm stated this in an article obtained by New Telegraph at the weekend. It noted that while the recession of 2008–2010 was triggered by a shock in the banking system, the current recession is different, given that “it was triggered by a global pandemic, governmental and societal response to it, and the resulting shocks to supply and demand.” According to McKinsey, “one of several expensive lessons of the global financial crisis is that building banks’ capital is not optional but a requirement. Other lessons include the speed at which the financial system’s plumbing can become clogged, the rapidity with which liquidity can disappear, and the difficulty of selling assets in a plunging market.” Pointing out that the COVID- 19 induced recession had adversely affected banks, the firm said: “The industry has already felt massive effects from the crisis, with more to come.
The banking systems in both Europe and the United States have roles to play in getting the economy back on track — for example, by providing loans to businesses that have suffered. “Capital cushions at Europe-an,UK, and U.S. banks look adequate in most scenarios — and challenged in others. In either case, they must be rebuilt, and that will require some difficult decisions,” it added. The management consulting firm, however, noted that how effective a bank-supported economic recovery will be, depends on banks’ resilience and health. “Losses from loan defaults and increases in risk-weighted assets will deplete banks’ capital.
The extent will depend on the spread of COVID-19 and the effectiveness of the publichealth response and mitigating interventions,” it stated. Considering three scenarios, which it said business executives around the world consider most likely, the firm said: “We find that in two milder scenarios, in which GDP does not recover to its pre-virus level until 2021 or 2023, $100 billion to $400 billion in Common Equity Tier-1 (CET1) capital would be wiped out in Europe, the United Kingdom, and the United States.”
“The good news is that the European and U.S. banking systems in aggregate can withstand damage on that scale, though individual banks may not fare so well. Entering the crisis, CET1 ratios 1 were 13 per cent in Europe, 14 per cent in the United Kingdom, and 12 per cent in the United States. Should one of the two milder scenarios prevail, those ratios would fall to 8.5 to 10.0 per cent in Europe, 11 to 13 per cent in the United Kingdom, and 8.0 to 10.5 per cent in the United States, all above regulatory minimums (standards that have seen some recent flexibility from regulators).
Some institutions would slip below the minimums, perhaps to a level that threatens their viability, but the systems themselves would survive. In either of these scenarios, the prudential regulation of the past ten years will have succeeded—an achievement worth celebrating.
“However, the milder scenarios are by no means a sure thing. Banks are taking massive provisions, and offering negative guidance for coming quarters. Should the morepessimistic scenario take place, bank capital could fall by as much as an additional two to three percentage points, bringing the CET1 landing point close to five to six per cent.” The firm emphasised that in any of the aforementioned scenarios, “banking executives must prepare for the next normal to be very different from that of the past ten years.
“Banks in mature economies have built significant capital buffers and operate in what we call the ‘cushion zone.’ In coming months and years, banks might pass into the ‘caution zone’ and need to significantly change the actions they take to preserve and raise capital, and decisions about dividends and buybacks, compensation, and cost structures need to be reexamined. The level and type of support that banks are able to provide to the real economy would also come under scrutiny, given their tighter capital positions,” it said.