Disruption does the most damage when it meets resistance. Although banks have risen admirably to the surge of demands imposed upon them in the aftermath of the 2007–2009 financial crisis, most have continued to fight back within the bounds of their existing business and operating models rather than yield and adapt to the systemic shifts underway.
As this year’s report makes plain, that approach hasn’t worked. Economic profitability is down globally, with returns shrinking in nearly every market. Income growth is lackluster, and despite continued efforts to rein in costs, most banks still have not been able to sustain the performance gains needed to secure their future. The current COVID-19 crisis, the strongest test that the global financial system has faced since 2007–2009—and whose long-term effects are still unknown—may make the challenges that much more difficult.
In addition to the sobering public health repercussions, the swiftness and severity of the outbreak has shuttered businesses the world over—for weeks and, in some cases, months, at a time. On a sectoral basis, we expect widespread and heterogeneous impacts. Banks will likely see margin and volume compression because of lower interest rates and a dampening of client activity and investment. Credit risk is a particular threat as clients come under increased liquidity pressures. Deteriorating credit quality among counterparties could result in ratings downgrades, greater default rates, and increased pressure on profitability and regulatory capital. Banks are pivotal in helping companies bridge liquidity shortages. Thanks to massive central bank intervention, volatility in the short-term funding market for banks is starting to subside. In the long run, however, banks might face higher funding spreads and need to adjust their funding strategies.
Most analysts think we’ll see some form of recession, though the severity is uncertain. What is clear, however, is that the more prolonged the crisis, the greater the economic risks. Between the first few weeks of “firefighting” and the long-term new normal, we will experience a hybrid stage that will last for at least three to six months, potentially much longer. To manage this transition effectively, here’s what banks need to do now.
Effective crisis response will require banks to:
We currently see a supply shock, demand shock, and oil price shock at the same time, and for the first time all regions worldwide are affected. The impacts will be different across industries. Gauging those effects will require banks to invest in detailed scenario planning, differentiated by industry sector.
Banks must also revisit their business continuity plans—looking not just at near-term impacts but at the wider ripple effects over the next 12 to 18 months. That planning must also extend to the operating model to ensure that banks have sufficient controls around processes like cybersecurity, anti-money-laundering, payments and liquidity, and credit.
Arguably, one of the most pernicious risks facing banks globally is not external volatility as much as it is a reluctance to shake up institutional practices and norms at their core. The tactical improvement efforts that banks have made haven’t delivered the transformation needed. Last year, we wrote that digitization is the key to resilience in the banking segment. This year, the unprecedented challenges posed by the COVID-19 outbreak make the digitization imperative all the more urgent.
Risk, treasury, and compliance functions can help banks respond to the present crisis and lay the groundwork for the bank’s long-term success. By using artificial intelligence, machine learning, and other advanced technologies and practices, they can improve bank steering; deliver predictive, real-time insights; and execute faster and more efficiently. Yet success requires a willingness to see disruption not as a threat, but as a lifeline.
Our thesis is straightforward: banks interested in reducing the risks to their business, enabling integrated balance sheet management, and modernizing compliance must develop a clear digital strategy, redesign core processes, and establish the right digital enablers. This report lays out the path to digitization and presents concrete examples of what that transformation looks like and the results it can achieve.