Will the coronavirus crisis rehabilitate the world’s banks?
‘We are the doctors of the economy,’ says one bank boss
An ATM in Valencia, Spain, displays a #StayAtHome message. Much now depends on banks’ ability to withstand coronavirus and its aftershocks. Photograph: EPA
On the day that Lehman Brothers filed for bankruptcy in September 2008, the front page of the Financial Times carried a photograph of John Thain, the then chief executive of Merrill Lynch. He was getting into his car after hours of talks at the Federal Reserve Bank of New York, and looked like a man who had stared into the abyss. In the following days more pictures would emerge of bankers leaving crisis meetings with policymakers, their ashen faces a portent of the horror to come.
As coronavirus rages and brings the global economy to a near standstill, bankers are once again roaming the corridors of power. In early March, Donald Trump summoned the chief executives of Bank of America, Citigroup and other large lenders to the White House, while Rishi Sunak, the UK chancellor, has held meetings and calls with their counterparts in Britain.
But this time is different, bankers say. Rather than being admonished for their role in causing the 2008 crisis, they are being called on to help distribute unprecedented stimulus programmes worth trillions of dollars designed to save the global economy from collapse. Although governments and central banks are providing much of the cash, lenders are being asked to serve as the “transmission mechanism” to ensure support finds its way to the companies and consumers who need it most.
Mike Corbat, chief executive of Citigroup, says the US lender is in “daily contact” with the White House and regulators, “relaying information ... [on] what we’re seeing in the marketplace ... what’s under stress”. In France, the finance minister and bank governor now speak daily to Frédéric Oudéa, chief executive of Société Générale, a bank that became a pariah in 2008 following a rogue trader scandal.
“The difference with 2008 is that we were seen as the problem then, everybody today knows the problem is the virus,” Mr Oudéa says. “We are one of the activities that has to function ... we are the doctors of the economy.”
While that description will jar with some, the difference in the tone of the discussions between governments, policymakers and banks has surprised some veterans of the financial crisis. “I don’t want to quote [former Goldman chief executive Lloyd] Blankfein and say we’re doing ‘God’s work’, but at least it feels like we’re on the side of the good this time round,” says one banker who advised the UK government in 2008.
Whether banks can maintain this new-found trust depends in large part on their ability to withstand coronavirus and its aftershocks. That in turn rests on whether post-financial crisis reforms – some of which the banks are lobbying furiously to relax – have left the system strong enough to survive. Banks appear to have passed the first test: a short but pronounced period of market mayhem and a co-ordinated drawdown of hundreds of billions of dollars of credit by corporations feeling the strain. One policymaker says that, faced with the coronavirus fallout, the global banking system of 2007 would have already imploded by now.
Jes Staley, chief executive of Barclays, says that “by any measure, the financial markets have traded and demonstrated volatility never seen before,” noting the “significant value destruction happening in pools of assets”. But, so far at least, the system is operating as it should. “It’s pretty extraordinary that with this amount of distress you haven’t seen more failures in asset management companies.”
He adds that the potential harbingers of a full-blown financial meltdown have not yet happened, such as a mutual fund preventing investors from making withdrawals. “There are just a lot of things you’d expect to happen before you start to see a real crisis,” says Mr Staley.
The real test of the resilience of banks and the wider financial system is yet to come. Huge swaths of the global economy, from airlines to retailers, have seen their revenues all but evaporate. Many companies and consumers will default on their loans, leading to a string of excruciating credit losses for banks that will hit profitability and blast a hole in their balance sheets. Meanwhile, ultra-low interest rates introduced by central banks to support the economy during the pandemic will put extra pressure on profits generated from lending.
“Everything in the world is on hold, and this cannot not be reflected in the financial world,” says Romain Boscher, chief investment officer for equities at Fidelity International. “Banks are still too big to fail, but also too crucial to disappear.”
$15 billion loss
Standard & Poor’s, the rating agency, last week warned that the US banking industry – which generated $195 billion (€178 billion) of profits last year – could swing to a $15 billion loss in the next 12 months. Analysts at Berenberg say US and European lenders are facing an average 30 per cent plunge in profits this year and next. “Confronted with reduced activity, lower-for-longer interest rates, inflexible costs and higher loan losses, the outlook for bank earnings is one-way traffic,” they wrote in a recent note to clients.
Despite these headwinds, some bank executives have projected confidence. Ana Botín, executive chairman of Santander, the euro zone’s largest lender, told a financial services conference in March that the bank was forecasting only a 5 per cent drop in earnings this year, and that it expected no impact on its capital levels or midterm financial targets. Appearing via video link from a locked down Madrid, Ms Botin said those estimates were based on a “V-shaped” recession – a sharp shock followed by a rapid recovery, but stressed this was only one possible scenario.
However, some bankers say that such talk is premature, bordering on wishful thinking.
“If someone can tell me when they think [the virus] is going to be contained globally, and we will get back to a normalised global economy, then I can tell you what the credit cycle will look like,” says an executive at a rival global bank. “But given that no one can predict that, I find it hard to see people going out and being so confident.”
The depth of credit losses hinges on the amount of risk that countries are willing to share with the banking sector. Governments and central banks have rolled out fiscal and monetary stimulus programmes on a scale not seen since the second world war, ranging from central bank-backed credit facilities to loan guarantees and bailouts for industries including the US aviation sector. One Swiss bank executive says that absent such extraordinary support, banks’ loss-absorbing capital buffers “would have been like a brolly in a hurricane”.
One banker advising the UK government - which has earmarked £330 billion for corporate loan guarantees and a commercial paper financing facility - says the schemes are untested. In particular, he warns that the guarantees will only apply to future lending. “It’s for new money, not for all the loans we’ve already made that are going to go bad.”
Bank executives have also warned that new accounting rules in Europe – which force lenders to set aside provisions for bad loans at an earlier date – will aggravate the problem by quickly impairing capital buffers and crimping their ability to lend at the very moment companies and consumers need cash. Policymakers are sympathetic, and have taken steps to reduce the shock of the new regulations. On Friday, regulators agreed to soften the impact of similar rules in the US.
But relaxing the rules will only buy time. “If the world blows up and all this government intervention doesn’t work, then this will eventually get to banks,” says the banker advising the UK government. “It will be an old-fashioned credit loss crisis, but on a scale not seen before.”
Even if banks can absorb the losses, some of the actions taken by policymakers will hurt the sector in the long run. Although recent interest rate cuts by the US Federal Reserve and the Bank of England are intended as a temporary measure, the 2008 crisis showed that central banks can struggle to increase rates once an immediate economic shock has passed. Meanwhile, a boom in first-quarter trading revenues for investment banks will probably only provide a short-term fillip.
Standard Chartered’s head of finance Andy Halford warns that “incredibly low interest rates” could cause corporate and retail depositors to move their cash out of accounts that have tended to pay a higher rate of interest in exchange for having the deposit locked up for a specific period of time. “Banks like to have deposit stickiness that can be used to underpin lending,” he says. “[If] there is less inclination to put money into sticky pots, there is less confidently there for circulation into the system.”
The coronavirus crisis might have given banks an opportunity to repair their public image, but it also brings new reputational risks. As the transmission mechanism for doling out state aid, they will be required to perform a thorny task: deciding which companies should receive financial assistance and which would have struggled to survive regardless of the virus, and should therefore be cut loose. One policymaker says “picking winners and losers” could provoke a long-term public and political backlash against the banks.
“We want to avoid any moral hazard ... governments should not just shell out money,” says Lars Machenil, chief financial officer of BNP Paribas, the French bank. “If a company, an airline for example, was in good shape in February then the government guarantees are [there ]just to get it through the Covid-19 period.”
Mr Corbat says banks must walk a “fine line” between “being as supportive as we can be” without “in any way calling into question the soundness” of the bank or the financial system. “The last thing that we all want to see is ... our consumers, our small businesses and our big businesses coming out of this ... [with a] precariously bigger or larger position of indebtedness.”
Although many retail and consumer borrowers have been given payment holidays, some will never be able to repay their loans, which could lead to a wave of bankruptcies and repossessions that will test the public’s patience.
“This crisis did not originate in banking, but they can be part of the solution, and it might engulf them if, instead, they turn away,” says Paul Tucker, chair of the Systemic Risk Council, a group of former regulators, and previously deputy governor of the Bank of England. “They must not gouge customers, and need to suspend dividends and high-end bonuses. It is not a moment to put themselves first.”
Peter Orszag, an executive at Lazard who was White House budget director in 2009-10 in the first Obama administration, warns that the new-found trust between banks and policymakers could come under strain.
“I don’t want to call this the honeymoon period, because what’s going on is so awful, but there is a bit of coming together and recognising goodwill,” he says. However as banks are forced to decide which consumers and companies receive support, political and public opinion could change. “What happens is that six months in the dynamic can start to shift – the backlash doesn’t start immediately.”
Like other businesses, banks are also facing huge logistical obstacles, with their scattered staff either working from home or off sick. A lockdown in India, where many lenders have chosen to locate call centres, is making it harder to deal with a deluge of incoming customer inquiries. Some banks have had to put restructuring efforts on hold, like HSBC, which last week said it would pause the vast majority of redundancies barely two months after it announced plans to slash 35,000 jobs. The cost of running a bank, already stubbornly high, is only going to rise.
Above all else, the survival of banks and the global financial system depends on whether governments can contain the public health crisis.
Brian Moynihan, chief executive of Bank of America, says the $2 trillion stimulus agreed last week by US lawmakers was of “a substantial size and dimension that most of us think is big enough to help do the trick”.
But he acknowledges the wider challenge: “What they’re doing on fiscal and monetary [policy] ... is terrific, but the real thing that they have got to solve is the healthcare crisis.” – Copyright The Financial Times Limited 2020