10 Dec 2020 Ankit Chadha

Financial Risk And Projected Implications Of COVID-19 On Banking Institutions

Financial Risk | TRC Corporate Consulting

Financial Risk And Projected Implications Of COVID-19 On Banking Institutions

The effect of COVID-19 on individuals, populations, and organizations had left the world standstill. In addition to the impact on supply and demand economics, COVID-19 has also affected financial markets. After the outbreak, bond yields, oil, and stock prices have dropped sharply on the global market. The instability and consequences of COVID-19 have also been encountered in our economy.

Rapidly shifting social norms, transport controls, slowdowns in the pace of economic activity, potential disturbances in the supply chain, high degrees of market volatility, and market sentiment are some of the preliminary challenges banks face. With continuing supply and demand shocks following the lockdown of certain parts of the country, there is a potential for further market disruption.

Therefore, financial risk management experts and assurance practitioners need to understand the implications of the outbreak on the banking business and the means to manage the risks stemming from it to ensure resilience effectively.

Regulatory actions to tackle the impact of COVID-19 on Banks

Financial risk advisors and regulators across jurisdictions have adopted legislation to minimize the financial and economic effects of COVID-19. For instance, The Bank of Ghana (BoG) has taken constructive measures to sustain market stability. Among other items, the BoG decreased its monetary policy rate from 16% to 14.5%, the lowest in more than seven years.

According to BoG, these steps are designed to allow banks and SDIs to provide more liquidity and financial support to critical sectors of the economy in order to mitigate the negative impact of COVID-19 on the Ghanaian economy.

Significant fiscal stimulus and accommodative monetary policy will help buffer against the economic effects of COVID-19 and help mitigate the negative impact on banks.

While the response from the government and regulators is timely, as the situation persists, further policy measures and initiatives may be needed to mitigate the effect of COVID 19 on national banks and customers. Besides, some of the following types of systemic risk demand thorough liquidity and financial risk management assessment:

  1. Operational Risk

The spread of COVID-19 resulted in job delays like never before. The ongoing challenge calls for the organizations to be versatile and agile with their operational and financial risk plans. The pandemic led to the temporary closure of some offices, as some workers are expected to operate remotely. The added administrative costs of supplying logistics for workers to operate remotely are likely to have an effect on sales.

Some banks can also encounter delays in orders for laptops, servers, and networking devices that can further affect productivity. There has been a global increase in malware and fraud incidents since the COVID-19 scare. This is attributed to the unprecedented influx of cybersecurity attacks conducted under the COVID-19 cover, with phishing attacks responsible for more than 80%.

During this pandemic, Zoom and other productivity tools helping remote employees suffered security breaches. Banks need timely action to improve the cybersecurity environment and protect sensitive data. Collaborating with financial risk management services and assurance practitioners can now undoubtedly make way for better risk mitigation plans.

  1. Market Risk

Currently, increased uncertainty and a fall in the value of several types of financial assets could impact the trading books of most banks due to increased market risk. The uncertainty created by the pandemic could lead to an increase in pressure on the local currency, resulting in a higher foreign exchange risk and turning into market risk. Banks could use value at Risk (VaR) calculations to calculate maximum possible losses at a given level of trust.

Financial risk management and liquidity risk leaders also predict how the decline in interest rates would have an effect on their rate-sensitive assets and liabilities, and the resulting impact on profitability. After the outbreak, the persistent market risk could further weigh the investor's risk appetite, thereby influencing the equity and bond markets.

  1. Credit Risk

According to Moody's, global default rates are projected to grow as a result of the pandemic. Financial risk management experts highlight that locally, the spread of COVID-19 would have a negative effect on many businesses primarily due to possible disruptions in the supply chains of manufacturing, domestic consumption, tourism, and exports, placing downside risks on their earnings prospects.

This, in turn, would impinge on the ability of such companies to fulfill contractual loan agreements with banks, contributing to a rise in NPLs. The granting of a six-month moratorium on principal repayments to companies in the airline and hospitality industries is expected to help provide relief to the affected organizations.

  1. Liquidity

In order to ensure sufficient market liquidity, multiple banks have interfered by reducing the primary reserve requirement from 10% to 8%. Financial risk leaders of the country state that banks may also need to turn to contingency financing plans (CFPs) due to heightened market uncertainty and possible limit/threshold breaches.

Some banks may already experience increased liquidity tightening. This could be due to increased withdrawals and higher counterparty defaults in the affected sectors, potentially contributing to decreased net inflows in banks, state liquidity risk experts.

  1. Capital Management

Despite the recent recapitalization, the pandemic is still expected to place downside pressure on banks' resources. Risk-weighted assets (RWAs) can be affected by higher charges due to increased uncertainty and higher counterparty risks. This potential rise in loan provisioning from higher pandemic default rates could increase the credit risk-weighted assets, thus reducing the capital adequacy ratio.

At present, it may be difficult to predict exactly how long the outbreak will last as such timely steps are required to mitigate the effect of COVID-19 on capital.

How Can TRC Corporate Consulting Help?

At TRC Corporate Consulting, our financial risk experts and financial risk management specialists offer solutions to bridge gaps and retain business resilience. Our services cover different systemic risk types, liquidity risk, market risk, and financial risk management. Our financial risk experts provide banking institutions with rapid COVID-19 impact assessment and re-examination of governance structures to develop appropriate risk controls for the varied types of systemic risk, liquidity risk, market risk, and financial risk.

As some sectors are of a higher risk due to the pandemic, we support banks develop a capital optimization procedure to strategically allocate capital among sectors and business units to maximize return for each unit of risk undertaken. For further understanding of our financial risk services, get in touch with us!