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Banks & Covid-19: 5 things to know

While the global financial crisis some 12 years ago left investors with a wary disposition regarding banks, it could prove a miss-step to allow lessons from the past to taint today’s investment outlook.

Here are five things to know about banks, the current crisis, and where we are seeing opportunities.

  1. Unlike during the 2008 Global Financial Crisis, banks are not the cause of the current economic crisis or positioned at its epicentre

    Today’s crisis is one of global healthcare first, financial markets second. No one person, company, government or country is to blame for starting it and there is no benefit to creating corporate scapegoats to carry the blame. Society will need to work together to solve it.

  2. Banks are a part of the solution

    Commercial banks are being called up by their respective central banks and governments for both immediate crisis-management measures and longer-term economic recovery plans. Central banks have responded to the crisis with waves of policy measures to ensure market liquidity and the smooth functioning of banks. Banks are being urged to keep lending in order to keep the economy alive, with government-backed loan guarantee schemes helping to preserve banks’ capital ratios and significantly reduce the riskiness of these loans.

  3. Banks are a vital monetary transmission mechanism – providing 80% of credit to the European economy

    Banks are the primary providers of business loans, which keep companies alive during lockdown and will be used to fuel growth and redevelopment when societies begin to re-open. We are growing increasingly confident with each policy action announced that policymakers realise that, in order to ensure banks keep lending and prevent a major ‘credit crunch’, they are going to have to absorb the economic losses banks would otherwise take. In our view, if they don’t, the banks will have no option but to batten down the hatches and protect themselves in an exercise of self-preservation. Hence the need for government guarantees on Covid-19 related loans.

  4. Banks’ capital positions are vastly different coming into this crisis and are between 2-3 times higher than they were going into the 2008 crisis

    Basel III provided the regulatory drive that has made banks safer over the last 10 years; the future shift to Basel IV should provide visibility over the coming years. Once this pandemic crisis is over, the quantum of capital that banks are likely to hold should continue to increase and the way risks are modelled should continue to improve, alongside the way liquidity provisions are handled.

  5. The wave of losses that are undoubtedly going to come from this crisis will be absorbed on an accrual accounting basis, rather than mark-to-market hits from trading books like in 2008

    This means losses will be recognised much more gradually as they develop, rather than with undulations in financial markets. This should give policymakers almost limitless potential to protect bank balance sheets, which is the direction of travel they are taking with all of the loan guarantee support mechanisms.

Investment considerations

European banks’ significant balance sheet strength going into this crisis, and their current valuations, suggest in our view that the sector is likely to emerge as a clear winner from this shock. The obvious risk to this view is that the virus peak and related impacts last much longer than anyone expects, the fallout on the economy is much larger than envisaged and this creates a vicious circle, resulting in a deep recession where no risk assets are immune. However, we are growing in confidence that policymakers are providing all the support required for banks and that capital buffers at the banks should be robust enough to withstand what we believe will be a sharp contraction and slow recovery over the next two-to-three years.

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