Credit Crisis Amid COVID-19: U.S. Banks Face $320B in Loan Losses

U.S. banks will face up to $320 billion in credit write-offs this year due to the pandemic, according to a recent report from consulting firm Accenture. Let’s read the complete story.

COVID-19 has taken the world by a storm leading to a global economic imbalance across financial institutions. The burden to keep the economy up and running will mainly fall on private lenders, as governments start to lessen the public stimulus and nudge people to the private-led debt. 

According to a new report from AccentureOpens a new window , U.S. banks will set aside up to $320 billion to cover potential credit losses in 2020 due to the pandemic’s financial strain. European banks, on the other hand, could lose up to $460 billion. According to Accenture’s analysis, many banks entered the pandemic with the financial resilience to absorb considerable credit losses, with the world’s largest banks holding capital reserves well above what regulators require. 

The report notes that the top five U.S. banks set aside $60 billion in reserves during the first half of 2020 and that European banks set aside almost $18 billion in the Q1 of 2020. 

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The Accenture report projects that banks globally will set aside up to 2.4% of their existing credit books to cover expected losses in unpaid loans. The projected figure is nearly double of what banks wrote off during the 2008 global financial crisis. 

The impact will vary across countries, depending on the level of government-led financial support programs and the severity of the public health aspect of COVID-19. In the U.S., around 9% of home loans were in forbearance as of June 2020, an increase of six percentage points since March 2020. In the U.K., payment holidays were issued on one in six mortgages and 1.5 million credit cards and personal loans.

Alan McIntyre, a senior managing director at Accenture who leads its banking practice globally, saidOpens a new window , “Banks will play a critical role in helping absorb the economic impact of the global pandemic and stimulating a rapid recovery for consumers and small businesses. 

“As public programs wind down, the burden of holding extra capital to protect against credit defaults will fall on banks’ balance sheets. To inform their credit management strategies, banks will need a clear-sighted and data-driven view of the current level of credit risk while keeping a long-term view of the customer at the forefront.”

In 2019, U.S. banks set aside $55 billion to cover potential loan losses. The report suggests that banks will need to hold an additional $210 billion to $265 billion to cover potential credit write-offs for bad loans in 2020, depending on the severity of the public health aspect of COVID-19. In Europe, banks might write off up to $460 billion in 2020, an increase of $370 billion from 2019; and in China, banks might write off up to $360 billion in 2020, a $190 billion increase from 2019.

Also Read: How Can Lenders Leverage Artificial Intelligence for Financial Inclusion?

Banks Face a Challenge of Extending the Credit and Current Loans

In the increasingly debt-driven economy, banks face the challenge of managing their existing loan books and making decisions around extending new credit to potential consumers. The Accenture report highlights that doing so could lead to record levels of public and private debt worldwide, which could reach around $200 trillion by the end of 2020, according to some financial analysts. This might expose the ability of businesses and consumers to repay their debts.

According to another research study published by ComprarAcciones.comOpens a new window , the biggest lenders in the U.S. and Europe are on course to record some of the biggest loan losses and deferred loans in 2020. As per the report, at the end of H1 2020, the top 5 U.S. banks reported that borrowers could default on up to $104 billion in debt. It was the first time since 2010 when potential losses from loans had crossed the $100 billion mark. On the bright side, these expected loan losses are still below the 2010 figure, which soared to almost $150 billion.

On the other hand, Bank of America set aside $5 billion during Q2 2020, which brought its total loan loss provisions to almost $20 billion. In the second quarter, its profits period dropped from $7.3 billion to $3.5 billion year-over-year (YoY).

Further, CitigroupOpens a new window allocated $5.6 billion for the same purpose in Q2 amid a 73% profit decline. “We are in a completely unpredictable environment. The pandemic has a grip on the economy, and it doesn’t seem likely to loosen until vaccines are widely available.”, saidOpens a new window Citigroup chief executive Michael Corbat on an earnings call. On the other hand, JP Morgan ChaseOpens a new window set aside $10.5 billion in Q2, adding to $8.3 billion that it had set aside in Q1 2020. Its profits also dropped by 51% during Q2.

According to S&P GlobalOpens a new window , U.S. Bancorp’s total credit allowance at the end of Q2 was $7.89 billion. It had set aside $1 billion in Q1 and $1.74 billion in Q2. For Wells Fargo, the total was $20.4 billion, following a $4 billion allocation in Q1 and $9.6 billion in Q2.

A study from Citigroup reveals that the top 15 U.S. banks had set aside $76 billion in loan loss provisions as of August 2020. At the same time, the top 32 European banks had set aside €56 billion. The $139 billion total was the highest on record since 2009 when the banks set aside a total of $186 billion for loan loss provisions.

How Can Banks Weather the Pandemic Storm?

Banks can adopt a strong data-driven and analytics approach for determining the health of businesses, which may be masked by furlough and payroll protection schemes. A data-driven method will allow the banks to view the broader landscape of the current environment and show how consumer behavior has changed.

According to Accenture, U.S. banks will also need to scale up their credit management resources and collections capabilities quickly, as many of these units have shrunk considerably over the past few years. The current situation may prompt banks to pull back on lending. However, banks need to consider that demand for credit will ultimately be met by non-traditional lenders – such as big tech companies and fintech companies – or organizations that offer to finance their own products and services.

Also Read: Banking in Public Cloud: Here’s What Financial Institutions Need To Consider

Credit Management Units Have Shrunk — What’s the Solution?

Over the years, banks’ credit management units have shrunk significantly. Many banks will need to ramp-up their credit resources and collections capabilities to a level beyond what they can traditionally handle to meet the expected rising levels of default. Banks can provide personalized advice and appropriate guidance by offering creative solutions to help customers bridge the widening financial gap by combining the digital technologies they’ve built over the past decade with their people on the front lines. 

The Accenture report provides some recommendations on how banks can strengthen their credit management capabilities and prepare their business and operations for upcoming uncertain challenges while managing conflicting priorities. These include

• Engaging with regulators to avoid/minimize unintended consequences leading to new credit drying up.
• Operating with clear guidance.
• Maintaining transparency on collections and recovery.
• Ensuring fair treatment for borrowers.
• Maintaining a clear view of customers’ creditworthiness.
• Managing balance sheet risk while providing advice that helps businesses and consumers navigate through the financial crisis.

McIntyre further addedOpens a new window , “Competition isn’t coming just from fintechs and big tech, but increasingly from large, well-capitalized companies offering finance options for their products and services. If banks attempt to aggressively reduce offers of credit, what might start as a slow trickle of customers turning to alternate lenders could quickly become roaring rapids that can drastically change the tide of lending.”

As banks face the pandemic heat, they need to handle existing loan books and, at the same time, make decisions about where to extend new credit. This will significantly impact tech giants and fintech companies as it is expected that the bank credits will eventually be met by these alternative lenders. In addition to this, banks need to employ data-driven analytic methods to gauge the development of the consumer market and get an idea about the improvement of the businesses post-COVID. 

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