8 minute read
Building a contingency plan
from #229 - April 2020
Speaking to Banker Middle East, Godfrey Sullivan, Managing Director & Partner at Boston Consulting Group, tells us what to expect in the months to come and how to strategise for it
Can you give us the best and worst-case scenarios for the financial services sector in this current situation?
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There are, of course, many unknowns surrounding the COVID-19 crisis, the first of which is the ultimate impact on human health across the world, and it remains impossible to say how far and wide it will spread before it runs its course. Financial institutions are facing a broad range of operational issues, including how to operate branches if client traffic significantly slows, how to operate trading floors, how to optimise investment management in volatile markets, and how to cope with the profitability hit caused by lower interest rates. The best-case scenario is that the global health community works together efficiently and effectively to find a solution to the crisis in the near future.
In terms of impact on the performance of financial institutions, the latest estimates at a global level, even with a significant degree of approximation, show a strong impact. Profitability may drop by 40 to 60 per cent, the cost-to-income ratio may increase by 15 percentage points, margins may decrease by more than 20 per cent, and non-performing loans may surpass 10 per cent.
What are your views on the interest rate cuts and benefit of the financial stimulus in relevant countries for the financial service sector?
Central banks such as the People's Bank of China and the US Federal Reserve have already taken measures to anticipate a potential economic slowdown by lowering interest rates with a direct impact on the bottom lines of financial institutions. Such measures could lead banks into unchartered territory given the fact that interest rates are either at historic lows or negative in a number of geographies. It's a given that Europe and Japan have been dealing with negative interest rates for some time now, but US markets are now starting to price negative rates for US dollars.
Certain governments will reasonably focus, with specific measures, on avoiding corporate bankruptcy and preventing people from losing their jobs. We are already seeing examples of these measures in the US and Europe, such as postponement of taxation to companies, programmes to support the income of families, or even more extreme measures such as using public funds to inject new equity in companies.
What are your views on the current measures taken by financial institutions in reaction to the outbreak of the pandemic?
The current measures being taken by financial institutions to navigate the COVID-19 crisis have been both prudent and correct. Around the globe and particularly across Asia, six essential actions have already been deployed:
Profitability may drop by 40 to 60% the cost-to-income ratio may increase by 15 percentage points margins may decrease by more than 20% and non-performing loans may surpass 10%
— Godfrey Sullivan, Managing Director & Partner at Boston Consulting Group
• Protecting staff and ensuring business continuity:
This includes reviewing business continuity plans, optimising internal communication to accurately and regularly inform staff, and reassuring employees that their well-being is the management's top priority. Simultaneously, institutions are now offering medical consultations and temperature screenings for staff, rotating groups of homebased staff within specific teams, and preparing management continuity if a senior leader is forced to self-quarantine.
• Responding quickly and thoughtfully to clients:
Institutions understand that clear and regular communication with clients regarding how the crisis is impacting overall financial markets and their savings is essential. Client connections now are being made in a more meaningful way by communicating the regional and global status of the crisis from a health perspective. Informing clients about the evolution of the markets, supporting their decisions not to sell financial instruments at a significant loss during a period of high volatility, and providing fast access to credit such as overdrafts or quick loans is proving very important.
• Managing physical networks and promoting alternatives:
Institutions are reviewing and promoting alternative channels and accelerating the deployment of the functions required in apps and digital platforms. In Asia, several banks have closed a significant amount of their branches and stopped teller services, making apps, and digital platforms essential. In Europe, some banks are asking clients that have internet banking contracts not to come to branches without an appointment or to use advanced self-service ATMs while cashiers opening hours are being temporarily reduced.
• Deploying agile and highly reactive stress testing to anticipate diverse scenarios:
Banks are setting up rapid and frequent stress testing and scenario analysis to set new limits and make credit card and market decisions. This is due to the unpredictable range and speed at which the coronavirus may spread, and institutions understand the potential implications.
• Proactively manage the credit risk of clients, especially corporate ones and SMEs:
Companies will experience increasing liquidity needs, that in the term, will be reflected in drawing on the unused part of credit lines. Supporting viable clients with specific solutions and enhancing credit management and collection capabilities for the ones that will not survive the downturn, is crucial.
• Launching and accelerating efficiency programmes:
We see preparation for a potential downturn and lower revenues moving forward, and banks are beginning to communicate their cost reduction ambitions to the markets and launch immediate, high-return initiatives with medium to long-term time horizons.
— Godfrey Sullivan, Managing Director & Partner at Boston Consulting Group
• Engaging in active dialogue with public stakeholders, supervisors, and governments:
Similar to the financial crisis between 2007-2009, banks are working on government-backed programmes to lend funds to struggling firms, and it is in the interest of lenders to show forbearance toward borrowers under challenging situations.
What are the vital things that board members and management executives should keep in mind in carrying out their business contingency plans?
In our view, board members and management executives must take specific steps both for the long term and the medium term. It is apparent that the global economy is facing a triple shock, on the supply side, demand side, and in-market confidence, and this was recently emphasised by the VIX index as it hit 55— not far from the highest ever level in October 2008.
The crisis has prompted companies in virtually all industries to seek an optimal way to navigate their way through, and banks need strategies to help maximise their level of resilience and prepare for any macroeconomic and financial scenario.
What key elements should also be included in ensuring the continuity and sustainability of the financial institution's business?
Financial institutions must take four additional actions to ensure business continuity and sustainability:
• Accelerate the move toward digital sales and service:
Banks must accelerate both retail and wholesale client migration to online channels and platforms, as well as foster new ways of working and interacting between relationship managers and clients such as phones and video channels. Many have already launched initiatives in this direction and seized the opportunity to make progress on their respective paths to becoming bionic institutions.
• Reinvent models:
Accelerating discussions and decisions regarding their portfolio of activities is key to continuity and sustainability, with an example being selecting asset class with a "right to win" in capital markets. Moreover, they should speed up analysis and decisions related to deconstructing the value chain, which could lead to determining which parts of the value chain to keep such as client fronting and which parts to outsource, such as trading, back office, and IT.
• Prepare for new opportunities:
Despite their difficulty to navigate and endure, economic shocks can also present unexpected opportunities. Banks should carefully search and screen potential consolidation opportunities and aim to enhance themselves for years to come. The next economic shock may be even more complicated, and they benefit from lower acquisition prices due to the current conditions.
• Rethink planning for low probability and high impact risk events:
In the aftermath of the SARS outbreak from 2002-2004, most financial institutions had identified pandemic flu as a critical risk event that could have an adverse impact on their balance sheets and business models. However, this gradually dropped from the risk inventory until the emergence of COVID-19. This is not the last time the industry will be tested, and banks require a more robust framework to be ready for low probability and high impact events.
In light of everything, what is your current outlook on financial markets and the global economy this year?
There is currently an open and ongoing debate among economists in relation to whether COVID-19 will trigger a significant economic slowdown, full-blown recession, or if it will fade away within a few weeks or months and permit a rebound. Regardless of what transpires, it is safe to say that financial markets, the global economy, and 2020 revenues and profitability are very likely to suffer as a direct consequence of lower interest rates and a minimum of six months reduced economic activity in base cases. Financial institutions must act immediately and decisively to contain the COVID-19 crisis, strengthen their resilience, and thrive in the post-crisis landscape.
