For most of us around the world, life has changed beyond recognition compared to how it was a year and a half ago due to the catastrophic effects of the Covid-19 pandemic. One of the biggest changes that we had to adapt to was the increased use of electronic devices. As we all stayed at home and continued with our jobs, the remote working situation meant that video conferencing for meetings and socialising, shopping online, digital banking, and so on went digital. The biggest question currently in front of us is how much of this change will prove to be permanent and which ones will turn out to be temporary ones?
When it comes to the banking industry, the change seems to be inclining more towards the permanent side. Considering where we are standing currently, experts say that digital experiences will rewrite the rules of retail and corporate banking. In a volatile world with rising customer expectations, it is important for the banking sector to be agile. Experts suggest that dynamic teams and systems must ensure banking delivers a seamless experience to every customer. While banking services can be provided remotely and don’t depend on direct customer contact, the banking sector plays an important role in supporting firms and households during this period of lower revenues and incomes. This has triggered important policy actions by financial supervisors and governments.
There has been a lot of news coverage regarding the effects of Covid-19 on the banking industry and how the pandemic has driven established banks to swiftly accelerate their digital programs in order to retain customers. As demand for digital features among customers increases, banks have prioritised enabling customers to complete the most common service journeys remotely, such as resetting PINs, changing loan terms, paying for groceries or filling in forms electronically. According to a report by RFI Group, 71 percent of global customers are now using digital banking channels weekly, which is a 3 percent year-on-year increase and daily use registered an increase of 6 percent. In the UK, 73 percent of the users are using digital banking channels weekly, which is way above the global average. Additionally, there was also an increase in mobile banking, which rose from 52 to 57 percent between the second quarter of 2019 and the first quarter of 2020.
From the above data, it can be easily inferred that the Covid-19 pandemic alone isn’t responsible for the sudden shift to digital banking. Instead, it has only accelerated the process since more people have access to digital ecosystems. The ones who are familiar with this topic would know that the change from cash towards digital payment methods has been building gradually for years. Going by the data provided by UK finance, only 23 percent of all purchases made in the UK in 2019 were paid by cash and in 2020, more than 70 percent of the population shopped online. Even if we take the Covid-19 pandemic out of the equation, these trends were expected to pick up in the next few years. Recently, The World Economic Forum predicted that 50 percent of the consumption of the total goods can be made online in major developed markets by 2030. Meanwhile, UK Finance expects only 9 percent of payments in the UK to be made using physical currency by 2028.
How did the Covid-19 crisis affect the banking sector?
When it comes to the banking sector, firms that stopped working started missing out on revenues and were unable to pay their loans. People who lost their jobs during the crisis were furloughed or had less income and therefore, might not be able to repay their loans. Not only will this result in loss of revenues, but it also negatively affects the profits and banking capitals, resulting in the need for additional provisions. Banks were also negatively affected when bonds and other traded financial instruments lost value, resulting in further losses. During any period of national or global crisis, banks face increasing demand for credit since most of the firms require an additional cash flow to meet their costs even in times of no or reduced revenues. In certain cases, higher demand has resulted in the drawdown of credit lines by borrowers. The Covid-19 pandemic also led the banks to face lower non-interest revenues because of less demand from various services.
Lower capital buffers in banks can result in making the bank’s solvency problem even worse and might also undermine the recovery of a broader economy. In order to recuperate from the losses, banks might start selling bonds and other traded financial instruments to make up for their losses or maintain their liquidity position in the market. Banks might also reduce credit provision to the economy and it will have a negative impact on the firms relying on such buffers, thereby making it difficult for them to survive in an already volatile and fragile market.
What has been the policy response?
The potentially negative impact on the banking sector has motivated concerned authorities in and across Europe to take precautionary measures and mitigate risks as much as possible. Authorities in the UK and Europe have reduced certain mandatory capital buffers and were present before the Covid-19 crisis which helped reduce the minimum capital ratio that banks have to observe. The authorities have also urged and encouraged banks not to pay out dividends or buy back their own shares during the crisis since it would further reduce their capital position. Additionally, the regulators have also delayed the implementation of new loan loss provisioning rules that would force banks to create provisions for loans that are currently impaired due to the crisis. Central banks have already reduced interest rates and extended the purchase of bonds. This makes the financing of the banks cheaper and it also provides necessary liquidity for banks to continue providing loans to the real economy.
Some governments have provided firms and workers with direct payments to substitute for their lost revenues. Even though this doesn’t have any direct effect on banks in terms of loss or gain, but it lets borrowers continue with their loan payments, which, in turn, help banks to avoid losses. Some governments have also provided direct support that helps banks, including loan guarantees which imply that part or all of the loan losses would be covered by the government if the borrower fails to repay their debt.
Developing smart governance
When a bank falls prey to cyber theft, it incurs a major loss in terms of revenue and customer base. Protecting customer information against cyber theft is one of the primary duties of the bank towards its customers. While cyber breaches started increasing, especially during the peak of the Covid-19 crisis, it is expected that this model will be adopted by numerous banks in future. This makes it increasingly important for financial institutions to raise their guards through the implementation of smart governance practices. Currently, more than 50 percent of data from banks are stored on the cloud, the transition to 100 percent will happen by 2023. But there are some crucial points that need to be kept in mind.
Firstly, banks have to ensure that they stop using personal or rented devices. But this step alone is not enough. Banks and financial institutions have to implement a series of controls and frameworks to monitor employee and user activity, transactions through authentication. Additionally, banks also need to start educating employee and customer education regarding safe banking habits so that threats can be minimised. Without proper training, it is easier to fall prey to financial fraud, hence, it’s best to ensure the bank is ready to face any challenge thrown its way.
The evolving digital landscape requires our utmost attention. It has already helped disrupt customer behaviour, preferences, and attitude, and very soon, it will change the entire banking ecosystem as we know it. In order to truly embrace new measures while looking for innovative solutions to better the existing operations, we can fulfil the changing requirements.
What needs to be done during the recovery phase?
Banks have been greatly benefitted from different supervisory and fiscal policy measures that have helped to avoid any bank failures over recent months. It has also provided support to the sector during the time when it was critical to keep the economy running. But these measures will not avoid losses that will result from the failure of some businesses and the inability of some households to repay their debts. So the important question who will bear these losses? In certain cases, the government takes care of the losses and for others, banks might incur these losses directly. Since banks played a critical role not only during the Covid-19 pandemic but also during the economic recovery phase, sufficient capitalisation will be important as economies will have to reallocate resources across sectors.
Sectors that rely heavily on physical client-provider services will slowly cease being important, but the sectors that shift their focus on remote or digital services will grow. Here, banks will have an important role to play where they can choose which sectors to give funding to. But, banks can only do so if loans provided to comparatively unsuccessful sectors doesn’t affect their lending capacity. Experts say that once economies have well-adjusted to the new normal, and it becomes clearer which firms are viable, it is imperative that non-viable firms are liquidated quickly.
What are some of the long-term effects of the Covid-19 crisis on the banking industry?
Since the world is still going through a tumultuous phase, it’s still early to predict what kind of long-term effects the Covid-19 recession will have on the banking industry. But there are some of the trends that are already clear.
The most popular trend that we have observed is low-interest rates and they are here to stay and it will certainly put pressure on banks’ profitability. Another trend that we have observed is that most banks are trying to move towards digitisation and it is predicted that this trend will only grow with time. As social distancing becomes common, the regular personal interaction between banks and clients becomes increasingly costlier. This might result in the closure of branches.
Industry experts have also predicted that all these factors will increase competition from fintech and the other tech companies like Alibaba, Tencent, Apple and Google to name a few. These tech giants are likely to come out of the crisis with a strong position to expand their presence further. This might put further pressure on banks that are in the core line of the business. Even though these trends started before the pandemic, they have been accelerated for sure.
The road ahead
During the first phase of the crisis, the banking industry was able to provide the appropriate response. The regulatory response was rather quick and to a large extent, quite effective. But it has also opened some shortcomings of the latest regulatory framework. Additionally, the use of blunt policy instruments such as industry-wide restrictions on dividend distribution is understandable during the time of an extreme crisis, but it comes with its own set of shortcomings. Therefore, it should only be used in extreme circumstances to avoid any additional loss. Going forward, it is extremely important that authorities strike the right balance between banks prepared to tackle the expected increase in non-performing exposures along with their role in financing household and non-financial corporations. While it is understandable that some regulators might want to ensure that individual banks are sound and solvent, it is equally important to keep in mind the aggregate, systemic perspective. Erring too much on the side of caution may hinder credit extension to the economy and have a negative impact on the perception of the industry by capital markets.
In the end, a banking sector that was previously healthier and more solvent helped the industry to absorb the initial shock of the pandemic and helped keep credit flowing to the economy, thereby preventing systemic risks from materialising. But the ultimate impact of the Covid-19 crisis on the banking sector will depend on the scale and duration of the pandemic and how effective the economic policies are in alleviating the effect of the pandemic on regular households and firms. Experts suggest that economic policies should continue to support the economy targeting the hardest-hit firms and population groups. It is especially important to support viable firms whose solvency has deteriorated after a year of crisis in order to prevent productive systems and employment from being destroyed. This would further allow the banking sector to remain part of the solution to the crisis by lending to households and firms and also contribute to the economic recovery once the pandemic is over. Lastly, the banking sector should also focus on tackling the challenges it faced before the pandemic, such as low profitability, along with new risks that come from intensive technology use and climate change.