Is The Second Wave Of Infection Nearing: Dilemma Around Banking Space And Economic Recovery?

While coronavirus outbreak created havoc across the word, the financial and banking sector seems to be worst hit in the pandemic led economic downturn. Besides, charting out path to recovery seems difficult amidst soaring government debt, squeezed incomes, crushed business confidence and tight labour market scenario.

Primary income sources of banks are interest from personal/ business loans, interests from investments and other sources such as income through foreign exchanges and others. While Job losses and business shutdowns have led to loan defaults and diminishing savings deposits, banks’ interest margins are under scanner amidst low interest rate regime.

Economy Vs Financial Market

According to IMF, the COVID-19 pandemic created more damage than anticipated during first half with recovery expected to be more gradual than previously forecast.

While Global GDP growth is expected to be -4.9% for 2020, 2021 will experience a bounce back of 5.4%. US is anticipated to witness a 8% fall and while China is expected to have a positive GDP growth at 1% this year.

According to June 2020 Global Financial Stability Report (GFSR), the rebound in financial market including stock market, is not aligned with the underlying economic prospects. The report highlighted that:

• Prices of Risk assets such as equities, commodities, high-yield bonds, real estate, and currencies have rebounded after a steep fall during February – March.
• Measures taken by central banks to ease economy did boost the market sentiment globally.
• With uncertainties still prevailing, there is a disparity in the recovery of the financial markets and real economic evolution that may prove detrimental for investors.
• Accumulation of high levels of debt may lead to losses and lead to insolvencies, testing bank resilience in few countries.

Banking Space Under Spotlight

Charts depict that the recovery path of S&P ASX 200 Bank index has not followed the same growth as S&P/ASX 200. However, major banks such as Westpac Banking Corporation (ASX:WBC), Australia And New Zealand Banking Group Limited (ASX:ANZ), National Australian Bank (ASX: NAB), and Commonwealth Bank of Australia (ASX: CBA) did experience a price rally in their share prices post March market crash.

One of the main reasons behind low market sentiments is that earnings of banks totally depend upon how the economy is faring especially individuals and businesses. Small to big businesses, all depend upon financial institutions to fund their growth prospects or strategic plans.

According to Australian Prudential Regulation Authority (APRA), $94.9 billion worth of mortgages were settled in the three months to 31 March 2020, up 20.1 per cent from $79 billion in the previous corresponding period.

However, the success in mortgage settlement did less to improve the banking sector’s financial position with latest authorised deposit-taking institutions (ADI) statistics revealing a 14.1 per cent decline in bank’s net profit after tax to $29.4 billion at 31 March 2020, below from $34.3 billion in the previous corresponding period.

While banks are exposed to pandemic-impacted businesses, Sectors which may support banks’ earnings are technology companies, online education, healthcare and consumer staple companies, which primarily operate on a recession proof model.

Banking Players Riding Through the Storm

Regulators around the globe have been relaxing rules for banks, with European Central Bank (ECB) allowing banks to use their capital and liquidity buffers and offering them the autonomy to operate below the level of capital conservation buffer and the liquidity coverage ratio. ECB also requested national authorities to relax their requisite countercyclical capital buffers.

US regulators also extended support to firms by allowing them to use their capital and liquidity buffers allowing banks to continue to serve households and businesses.

The need to draw capital buffer arises as companies across industries are suffering business setbacks prompting them to draw more credit lines from the banks to support their working capital and liquidity stockpile cash. This trend is expected to continue as 2020 economic growth is expected to remain negative.

Banks need to frame out strong internal liquidity-management practices such as monitoring corporate-deposit rates and interbank lending along with upgrading risk models and be prepared for refinancing from central banks to support changing customer borrowing needs in the highly volatile market.

Morrison government’s latest $250 million stimulus package has been designed to boost the economy. The package includes phased rollout of new grant and loan programs in over the next 12 months to support the $1.2 billion media and entertainment sector employing approximately 600,000 Australians. The stimulus package includes concessional government-backed “Show Starter” loans of worth $90 million to fund new projects in creative media to be facilitated by commercial banks.

The new normal - Digitization

The pandemic is challenging traditional banking habits. The community spread of the coronavirus has proliferated contactless payments that has prompted banks to opt for digital channels to serve their customers. Apart from facilitating payments, digitisation is required to find alternatives to support in-person banking.

Second wave of infection and its implication on banking sector

Victoria is experiencing a surge in community transmission with almost 116 new cases in the third week of June. State of emergency has been extended by four weeks to July 20 with stricter rules in social distancing.

The spike led to closed borders beyond July for few states despite Prime Minister Morrison’s urge to allow inter-state travel to boost tourism and the economy.

With social distancing tightening, a second wave of infection can have a serious impact on banking sector.

Economy spiralling down means increasing unemployment, business losses and other uncontrollable factors leading to more accumulation of debt, less earnings, and increased dependency on the Central bank for sustainability.

Volatile economy and distressed banks may also lead to consolidation with big banks acquiring the smaller ones.

While anticipated second wave of infection is a matter of growing concern for charting out path to economic revival, it will be interesting to watch how banking space evolves wrt capital buffer positioning while extending financial aid to distressed people and businesses. Besides, much anticipated negative interest regime will be important to look at from economy’s standpoint.