By Simon Tatam
Although the turmoil caused by COVID-19 has been unprecedented and the impact is still being felt and assessed, MHC’s Simon Tatum (Director, Head of Treasury) sets out some of his initial considerations on how financial institutions and corporates are likely to be affected, and what this might mean from a treasury and liquidity risk management perspective.
After the last financial crisis, regulatory bodies implemented new regulation that required banks to change behaviour and hold adequate buffers to see out periods of liquidity stress. The implementation of standardised liquidity metrics such as LCR, NSFR mean that banks now have a view of what liquidity they have, what they are doing with it and how long they will be able to survive. These measures have assisted in the creation of a more robust framework for the measurement and assessment of banks’ liquidity profiles.
It is likely that some challenger banks may well encounter liquidity issues. Although they are, like larger banks, required to comply with liquidity metrics such as LCR, the business models operated are often more specialist in nature. For example, in retail financing (e.g. car finance, home furnishings) COVID-19 means that there is now a significant risk of increased rates of default among retail clients coupled with a significant downturn in new retail lending activity, at least in the short term and quite possibly longer. Customers will also be depleting their savings due to a reduction of income due to redundancy or furloughing, and it will be more difficult to attract new deposits. Furthermore, lower liquidity inflows are occurring as a result of mortgage and loan repayment holidays. These combined factors will inevitably lead to a revision of some business models, and the approach taken to stress testing and liquidity risk management will need to be reassessed. There is also likely be some consolidation in the sector, and a resultant lack of appetite for further new entrants to make a foray into the banking sector.
The insurance sector has seen greater focus on the establishment of robust liquidity risk management frameworks since the publication of Supervisory Statement 5/19 in September 2019. Given the impact of COVID-19, there will have been an inevitable increase in claims against certain policy types such as business interruption insurance. It is highly possible that the stress testing models created and utilised have not fully anticipated an impact of this scale and, therefore, do insurance firms now need to revise their risk appetite and stress/scenario analysis and the assess the resulting impact on liquidity?
A flick through the financials of any large corporate highlights the lack of detailed commentary and discussion around liquidity risk with many corporates focused on the availability of credit facilities that they have been granted by the banks. Given that corporates were among the first to report liquidity issues very early on in the crisis (e.g. airlines), could corporates consider the adoption of some elements of the liquidity risk management techniques and practices seen in financial institutions to enable them to better withstand the impact of a stress on liquidity? Would the publishing of liquidity metrics give shareholders an understanding of the liquidity risk profile of the corporate?
The larger financial institutions generally look like they are able to weather the storm, with the significant levels of liquidity and capital that they hold. The key concern is where banks have extended credit facilities into the corporate sector and these are being drawn upon. If large scale defaults start occurring, there is a risk of contagion that could start impacting the balance sheets of the banks.
The post COVID-19 fallout will inevitably lead to cost reduction exercises taking place. The CEO of Barclays announced recently that the concept of maintaining large offices could be under review. Another consideration is that lockdown has forced more people to adopt the use of online banking services, so will Banks also start to consider the number of branches they want to maintain going forward?
Whilst these are unprecedented and troubling times, there are signs we are hopefully over the worst although we are clearly a long way off being back to normal – or whatever will be defined as normal – and there is likely to be a continued impact on our daily lives for the foreseeable future. However, as the dust settles, senior executives can start to reflect and assess where weaknesses have been identified and commence planning to ensure that the treasury environment and liquidity risk profile of their business is both robust and future proofed to meet the challenges ahead. The MHC Treasury team is ready to engage with our clients to see how we can assist in navigating any challenges they are encountering.