How sick can banks get?
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FROM EBENEZER SCROOGE à Gru in “Despicable Me”, the redeemed villain is an age-old trope in fiction. Much has been said lately about bankers benefiting from a similar rehabilitation. Reckless overextension by lenders was the root cause of the 2007-09 financial crisis. This time, the fault lies with a microbe, and not with money men, and banks are seen as potentially part of the solution, especially as vectors of massive state support for businesses and corporations. affected households.
The corona crisis is indeed giving banks a chance to improve their image. But it also presents them with painful dilemmas and, even worse, can hurt their results. Michael Corbat, CEO of Citigroup, has warned that banks like his have to walk a “fine line” between supporting customers and undermining financial stability. They need to conserve their capital while keeping dividend dependent investors comfortable. However they handle such choices, the risk of big losses looms: Bank stocks have fallen twice as much as the stock market this year for fear of an increase in defaults.
The industry entered the crisis in good shape. The capital cushions, exhausted during the last crisis, have since been replenished. Banks have also become less vulnerable to funding rushes. This time the system creaked but did not warp. Early evidence suggests that post-2009 efforts to push liquidity risk from banks into capital markets have worked, and to the extent that risk has rebounded, it has been largely absorbed by central banks through their debt programs. market support, not by commercial banks, says Huw van Steenis of UBS, a Swiss lender.
As part of these programs, and of their own momentum, banks have significantly increased their lending, especially to the United States (see graph). In March, state-owned enterprises took $ 191 billion from bank credit lines, after taking almost nothing in January and February. The odd one out is China, where loan growth is similar to last year. In 2008-09, authorities forced lenders to lead the stimulus efforts. They may fear that another such push might break them. Chinese bank assets swelled to 285% from GDP, compared to 195% in 2007.
To encourage banks to lend more and offer forbearance, Western regulators have rushed to relax or delay the rules put in place after the financial crisis. These cover everything from accounting for loan losses to the thickness of capital buffers (see chart). According to one estimate, such (presumably temporary) regulatory forbearance created $ 5 billion in lending capacity.
At the same time, regulators in Europe in particular have pushed or ordered banks to beef up their defenses by freezing payments to shareholders and star performers. British banks, for example, are withholding £ 8 billion ($ 9.9 billion) in dividends. The Americans did not follow suit, although they suspended share buybacks. Bonuses are also in the sights of regulators: Andrea Enria, the European Central Bank’s top banking supervisor, called for “extreme moderation”.
For now, the threat to the banks does not appear to be existential. “Unlike 2008, this is mainly a question of profits, not of the balance sheet,” says Nathan Stovall of S&P Global Market Intelligence, a data provider. If the write-offs are similar to those at the time, the capital ratios of US banks would remain above their levels after the recapitalization in 2008-09.
But with the big savings shut down indefinitely, the loan losses could be bigger this time around. Analysts don’t appear to be able to downgrade bank profit forecasts quickly enough. Some now believe that US banks, which made combined profits of $ 230 billion last year, could sink into losses in 2020. The investment banking will not be to the rescue. Equity issues and corporate transactions have slumped (although the increase in debt remains strong in the pockets). Trading volumes and profits have jumped, as they often do at the start of a crisis, but are expected to drop dramatically.
Europe is in a worse state. A senior banker says the outlook for UK lenders is “really crappy”. He fears that some small banks and non-bank providers will survive. Italian lenders, battered by the euro crisis, were on the mend until covid-19, after halving their bad debts, but now appear precarious again. Deutsche Bank, which has struggled for years to regain good health, risks a relapse.
In China, the shock to growth will push banks beyond the limits of what regulators had anticipated. In 2019, the central bank tested the resilience of 30 banks in various scenarios. In the most extreme blow envisioned for the economy – with growth slowing to 4.15% – he said 17 of the 30 banks would need more capital. The World Bank expects growth this year of just 2.3%. S&P estimated – based on an assumed growth of 4.4% – that the bad loan ratio could climb to nearly 8%, quadrupling from its pre-virus level. The questionable loan ratio could reach 13%.
Growing concern in the West is that the short lockdown and quick comeback scenario is turning out to be overly optimistic. Several months of additional restrictions could mean years of loss on bad loans. Bankers may begin to discover that there is a fine line between forbearance and forgiveness: In the United States, calls for indefinite cancellation of credit card interest are increasingly heard .
Another headwind is the ultra-low interest rates set by central banks to fight the pandemic. An important factor in a bank’s profit is its “net interest margin” (NIM) – the difference between the rate at which it grants loans and that at which it remunerates the deposits it has collected. Even before the corona crisis, it was a paltry 3.3% for US banks. With key rates likely to remain unchanged long after the end of the pandemic, NIMs will remain emaciated for years to come.
Whether banks end up drowning in red ink, or just splashed with it, depends on a multitude of unknowns. “The tail event is not a vaccine a year from now,” said Sir Paul Tucker, chairman of the Systemic Risk Council, a group of former policymakers. “Banks need to be subjected to such scenarios because post-crisis capital requirements have not been calibrated against something like this.”
In an April 6 letter Jamie Dimon, boss of JPMorgan Chase (JPM), assured shareholders that the bank could comfortably withstand an extreme scenario (“and, we hope, unlikely”), in which GDP fall by 35% and unemployment reaches 14%, emerging with capital above the minimum security. JPM is the strongest and most profitable of the major banks in the world. Others, faced with such a storm, could find themselves in difficulty. ■
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This article appeared in the Finance & economics section of the print edition under the title “This time we are different”