How well prepared are the banks for COVID-19?

  • By Christine St Anne

Credit losses for Australian banks are expected to double in 2020 amid the corona virus pandemic, but the sector is still well positioned in comparison with international peers with current regulatory action another positive for the industry.

On Tuesday, two ratings firms provided an assessement of the sector following the pandemic.

In a detailed note, S&P believes that overall, Australian banks can absorb the increase in credit losses and disruption to funding markets due to the now branded COVID-19 outbreak without posing any immediate or significant risks to the banks' creditworthiness.

S&P has based this analysis on its expectation that Australia's real GDP growth will fall below its previous forecasts in March – that is 1.2 per cent in 2020 - and a rebound in 2021 although the “situation remains fluid”. 

However, S&P does see headwinds for the sector including low and declining interest rates, a likely further decrease in demand for credit, and continuing customer remediation costs in relation to governance lapses in recent years. 

Another detailed note from Fitch Ratings also highlighted that regulatory action to date will support the banks.

S&P’s focus was the COVID-19 impact on bank creditworthiness. 

The ratings firm estimates that Australian banks' credit losses will nearly double in 2020 - to about 30 basis points of gross loans and advances - from historic lows in 2019 following COVID-19. 

“Nevertheless, in our view the credit losses should remain low compared with international peers as well as our expected long-term averages,” S&P said. 

“We believe that Australian banks retain headroom in their earnings to absorb a rise in credit losses even beyond our revised forecasts, without posing significant risks to their creditworthiness.” 

For S&P, business loans will contribute to most of the initial increase in credit losses for the Australian banks, with the travel, hospitality, retail-services, and transport related sectors likely to be among the more severely hit. 

Fending off a funding squeeze 

And while consumer and business confidence has been subdued following the recent bushfires and storms, with “likely second-order effects on the economy and banking system such as job losses – S&P expects the impact on the Australian banking system to be relatively small in the short term on the back of sound long-term economic prospects and its forecast rebound in economic growth as this event passes. 

“We also expect that fiscal stimulus from the Australian government should somewhat support short-term economic outcomes.” 

S&P analyst and author of the report Sharad Jain said that smaller banks would also be able to absorb credit losses from the COVID-19 impact.

However, he noted that unlike the majors, these banks don’t have a big lending exposure to small or medium sized businesses while the impact of personal lending will take a while to assess. 

In terms of funding challenges for the big four, S&P believes banks are prepared and support from the Reserve Bank should “fend off” a funding squeeze.

According to S&P, the major Australian banks have headroom and capacity to issue covered bonds to supplement their funding, if needed. In addition, the banks hold a good level of liquid assets on their balance sheets. 

The banks have access to the RBA Committed Liquidity Facility, which was set up following the global financial crisis to help Australian banks meet unforeseen liquidity needs. A

As signaled on Monday, the RBA is also prepared to support liquidity of the secondary bond markets as well as its plan to conduct longer-term repurchase operations of six-months maturity “as long as market conditions warrant”. 

S&P also expects many Australia-based fund managers are likely to choose debt issued by Australian banks in preference to offshore investments because of geographic proximity and likely better understanding of local operating conditions. 

“We also expect that a larger proportion of new savings will accrue to the Australian banks in the form of customer deposits as the impact of the outbreak continues, with retail customers likely to become more risk averse. 

“These developments should at least partly offset the impact from a disruption in the Australian banks' access to offshore borrowings.” 

Regulatory support 

Fitch Ratings believes Australia's key financial regulators will continue to provide any necessary support to the banking and financial system while the world faces the COVID-19 outbreak. 

The action by the Council of Financial Regulators and the government has “been aimed broadly at shielding the economy from the impacts of COVID-19, and promoting stability and liquidity within the financial system”. 

Fitch has a negative sector outlook for the Australian banking system, reflecting a number of challenges inlcuidng a low rate environment.

“The rapid development of the outbreak adds further uncertainty to the system and downside risk for bank ratings,” Fitch said.

The ratings firm believes the impact from COVID-19 will felt mostly through asset-quality and earnings pressure.” 

As outlined by S&P Fitch also sees weaker loan quality coming from highly affected sectors such as tourism, education, discretionary retail and some commodities. 

“However, second-order impacts from a weaker economy, rising unemployment, low confidence and higher market volatility could result in broader and more sustained asset-quality pressure,” Fitch said. 

Fitch also believes the investment in technology and digital banking channels over recent years - particularly at the larger banks - means they are better positioned than at any point in the past to deal with short-term operational disruptions and business-continuity planning. 

The caveat here again is that the severity of the impact on the banks will increase the longer it takes to contain the outbreak. 

However, Fitch notes that APRA continues to work with the banks to ensure they have sufficient contingency plans in place to cope with the ramifications of the outbreak on business continuity and mitigating risk. 

While not Fitch’s base case, “a severe downturn, could see the regulator follow some global peers and delay the implementation of new regulatory rules or temporarily lower regulatory buffers in an effort to allow banks to continue providing credit.”