As the Covid-19 health crisis starts to wind down, a new report cautions that the banking industry faces a challenge that rivals the economic tumult of the pandemic: a new era of economic uncertainty fueled by business defaults and insolvencies that could fray the rating quality of their loan books.
According to the Boston Consulting Group”™s newly published “Global Risk 2021: Building a Stronger, Healthier Bank,” the pandemic-related economic impacts of job losses, lower consumer confidence and supply-and-demand disruptions coupled with historically low interest rates can create post-challenges that will test the banking industry”™s risk management abilities.
Although the report credited banks for being better prepared for the pandemic than other organizations ”” due primarily to regulatory reforms enacted in the wake of the Great Recession”™s wreckage ”” a continuation and deepening of the ongoing crisis will test their mettle further.
“Resilience has its limits,” the report bluntly stated. “As the pandemic enters its second year, many banks will need to brace for an uptick in nonperforming loans and the resulting balance sheet impact.”
The report forecasted the situation could become more dire for banks as pandemic-era stopgap policies, including a moratorium on bankruptcy filings expires and government relief programs come to an end. The near future, the report stated, will see a renewed wave of business insolvencies that were temporarily frozen by federal policies in 2020.
However, Gerold Grasshoff, a managing director and senior partner at Boston Consulting Group and a co-author of the report, saw this near-future scenario as a chance for banks to become better prepared in addressing and mitigating the problem before it metastasizes.
“Institutions now have a real opportunity to seize the moment and secure their own stability and resilience by reinforcing their core processes and working models, solidifying their foundations and boldly acting on emerging opportunities,” he said.
The report called on banks to create a six-step agenda designed to withstand the difficulties before them. This agenda includes the following considerations:
Shifting to an active credit portfolio management. The report”™s recommendation is to move from the traditional buy-and-hold strategy to “an active-management mindset that expands the credit focus from optimizing returns on individual loans or sub-portfolios to optimizing risk-adjusted returns across the entire credit portfolio.” This can be achieved if chief risk officers give credit teams portfolio wide visibility, thus “enabling that broader view can help institutions avoid undue risk concentrations and be more responsive to changes in the market.”
Augmenting collections and workout capabilities. As nonperforming loan levels rise, the report called on collections units to update their segmentation and loan book analyses, refresh their early-warning systems and realign staffing to stay on increased surge of collections and workout activity over the coming year.
Optimizing balance sheet management. Low interest rates and high levels of administrative expenses prior to the pandemic exacerbated bank performance during the crisis, with the credit agency S&P Global reported 236 negative rating actions on banks globally since March 2020. The report”™s recommendations focus on identifying and mitigating credit risks before they get out of control, coordinating interest-rate risk management strategies that favor long-term fixed-rate items and review current liquidity buffers to guarantee they will not weaken.
Upgrading compliance and nonfinancial risk management. The report called on banks to “ensure that compliance and risk teams have a common language for tracking and discussing relevant risks” while establishing lines of defense against all potential risks ranging from cyber risks from outside of the bank to misconduct from within.
Accelerating digitization and cloud adoption. The report stated that “end-to-end automation of critical risk processes, such as credit, can help institutions respond to changing events with agility.” Cloud computing was cited as increasing agility and resilience while driving down infrastructure costs by up 30%.
The report pointed out that banks need to pay closer attention to environmental, social, and governance (ESG) risk management. While this issue is more pressing in European financial institutions ”” those across the Atlantic will need to integrate ESG into their stress testing by the first quarter of 2022 and have their first disclosures on ESG risks in place by Dec. 31, 2022. Grasshoff recommended that U.S. banks follow their lead in order to speed further into post-pandemic recovery.
“The banks that are ahead of the curve have already integrated ESG risk management into their strategy and are now working on integrating ESG into their core banking processes and methods,” he said.
