Other parts of this series:
The likelihood of a quick, V-shaped COVID-19 economic recovery is fading in many countries. The impact of the downturn—lower incomes, further job losses, diminished demand and more—is likely to endure, driving many consumer and business borrowers into default. A torrent of delinquencies will cause a new credit crisis that is likely to swamp but not sink the banking system. 
As I mentioned recently on the World Economic Forum’s COVID Action Platform (Accenture leads the WEF’s COVID-19 Banking and Capital Markets Industry Action Group), this economic crisis is already unfolding across three overlapping phases. The first is characterised by public-led stimulus programs, in which governments quickly allocated about US$11 trillion of fiscal relief and monetary policy actions to immediately shore up credit-market liquidity. Banks are playing a vital role in the distribution of much of these funds to both consumers and businesses.
As these public programs wind down, the burden of liquidity support will fall to banks and other lenders. This will be phase two: private-led debt provision. This could lead to record levels of public and private debt—up to $200 trillion worldwide by various estimates, some of which businesses and consumers will not be able to repay. In this debt-driven economy, we expect a rapid increase in banks’ impairments across a wide range of asset classes. Banks will need to manage their existing loan books while also making decisions about extending new credit.
In an adverse COVID-19 scenario, we could see banks’ pre-tax return on equity fall below zero in both the US and Europe, although banks are likely to remain profitable in Asia. Banks could write off up to 2.4 percent of their existing credit books—more than during the 2008 global financial crisis. Just a slight increase in provisions could result in net losses for banks that were already struggling with low profitability before the health pandemic (particularly in Europe).
[Banks] need to strike the right balance between supporting individual and business customers while protecting their own profitability and solvency.
Consumer and business demand for new credit will likely be high in this second phase of the credit crisis, requiring banks and other lenders to be even smarter about extending new credit. The issue is not just about reassessing their credit appetites and product mixes across credit business units (such as loans, cards, lines of credit and so forth) but also ensuring loans are granted to enable consumers and businesses to stay afloat rather than simply delaying the inevitable. Banks will need to be cautious—but too conservative an approach could result in a loss of business to alternative lenders, like automotive companies, durable goods manufacturers and supply chain financers that are also finding ways to satisfy the credit demand.
Then, the expected high levels of risky debt will lead to the third and final phase of the crisis: equity restructuring. It will be triggered by the realisation that in a post-COVID world of soft demand, many businesses may not be economically viable and will not be able to pay their debts. In hard-hit sectors, like business travel and commercial real estate, the new conditions could turn profitable, viable businesses into vulnerable and unattractive borrowers. And unfortunately, small and medium enterprises are likely to suffer most, as there are no easy mechanisms for equity restructuring apart from letting businesses go bankrupt and then hoping boarded-up storefronts and shut-down factories will be repurposed by new owners when the economy recovers.
Despite the gloomy outlook, the next few years will also offer an opportunity for banks to be heroes, absorbing the economic impact of the credit crisis and working with governments and other agencies to stimulate a rapid recovery. They will be expected to provide not only the capital but also the advice that builds a bridge to a more stable macroeconomic environment. Most banks are well-prepared to play this role, having had high capital levels when the health pandemic began (by our analysis, the largest global banks had a common equity tier 1 ratio of nearly 15 percent in mid-2019) and then moving quickly in the first quarter of 2020 to set aside material provisions to cover projected loan losses.
Now their juggling act begins. They need to strike the right balance between supporting individual and business customers while protecting their own profitability and solvency. It means taking a clear-sighted and data-driven view of the current level of credit risk to inform their credit-management strategies, with a long-term view of the customer at the forefront.
In my next post, I will highlight four actions banks should consider taking as they navigate their paths through the crisis and beyond. Until then, I invite you to read our full report, How Banks Can Prepare for the Looming Credit Crisis.
