Impact of COVID-19 to the Banking Sector

In the wake of the novel coronavirus pandemic, both regulators and financial institutions are steering through unchartered waters. From maintaining cash and liquidity to re-adjusting operations, banks will need to navigate complex government support measures in order to safely weather the current crisis. This article takes a brief look at measures introduced by Hong Kong SAR regulators to ensure liquidity and access to capital, the current cooperation by banks and regulators to maintain financial stability, as well as challenges banks continue to content with. 

Regulatory response to COVID-19 in Hong Kong SAR

With global supply chains disrupted and many physical places of business closed, the scope of impact to individuals, small and medium enterprises (SMEs), as well as large corporates is still unknown. What is evident is that all groups are facing a cash flow crunch that threatens economic and financial market stability.

In response to the impacts of the pandemic, the Hong Kong Monetary Authority (HKMA) and the Securities and Futures Commission (SFC) have announced a broad range of support measures to maintain financial stability. 

Various temporary exemptions as well as capital and liquidity management support were announced to enable banks to devote additional resources during a time when they face an unprecedented demand for liquidity. These measures include:

• Lowering Liquidity Buffers
  HKMA will accept authorized institutions (AIs) under the liquidity coverage ratio (LCR) and liquidity maintenance ratio (LMR) regimes to operate with a lower level of liquidity ratio to meet their liquidity demand and support business activities of its clients affected by the COVID-19 pandemic.
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• Reduction in Countercyclical Capital Buffer (CCyB)
  HKMA decided to relax the requirement on CCyB ratio further from 2.0% to 1.0% in March 2020 with the aim to strengthen the resilience of the financial system. The additional capital that banks have accumulated can now be released to lend to businesses, partly offsetting the adverse impact of COVID-19.
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• Reduction of Statutory Regulatory Requirement to 50%
  To ensure that banks have sufficient capital to support businesses overcoming the impact of COVID-19, the HKMA announced the relaxation of the statutory regulatory requirement (SRR) from 100% to 50%.
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• Basel III implementation deferral
  To provide more headway for banks to focus on responding to the COVID-19 pandemic, the HKMA announced the decision to defer certain Basel III reforms by one year to 1 January 2023. The deferrals are as follows:
  
  • Revised frameworks on credit risk, operational risk, output floor and leverage ratio by one year to 1 January 2023;
  • Implementation of the new market risk framework and revised credit valuation adjustment (CVA) framework to no earlier than 1 January 2023. 
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• Pre-approval of Principal Payment Holiday Scheme for Corporate Customers
  HKMA developed the scheme to instruct participating banks to pre-approve deferment of loan principal payments that are falling due between 1 May 2020 and 31 October 2020 of eligible SMEs for up to a period of 6 months.
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• Postponement of 2020 Supervisor-Driven Stress Test (SDST)
  In order to reduce the operational pressure on banks and to focus on responding to the challenges of the pandemic, HKMA has announced the postponement of the 2020 SDST exercise to 2021.
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• Margin requirements for non-centrally cleared OTC derivative transactions
  In light of the COVID-19 pandemic, the SFC has announced the extension of the initial margin (IM) requirements by a year in line with the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO).
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Challenges faced by the banking sector

As evidenced by the immediate measures taken by regulators to ease restrictions on liquidity and capital, banks are providing an important social good to economic actors and individuals in this time of crisis. 

Although support measures introduced by regulators have certainly helped banks fill this role, they still face some immediate pressures on their capital and liquidity position, as the length and severity of this outbreak remain uncertain. These include:

• Potential draw-down on credit facilities by clients
  Banks play a critical role to ensure the availability of funds is sufficient to support individuals and businesses without jeopardizing their own liquidity position. As a result, banks may need to recalibrate their existing liquidity stress models to cater for sufficient capital if significant drawdown of loan facilities is required. 
• Revision to loan loss provision estimates
  As the economic outlook remains highly volatile, expected credit losses previously calculated will need to be revisited to account for the uncertainty and scale of the pandemic. Banks is likely to witness an increase in their expected loan loss provision.
• Additional capital requirements to maintain capital adequacy ratio
  The economic downturn will likely see a rise in non-performing loans. Banks may have to perform a reassessment on their existing loan portfolio to account for any increase in credit exposure and to allocate more capital to address the higher credit exposure.
• Compressed net interest income margin
  The HKMA lowered its base rate to 0.86% in March 2020. Although the cost of funding will be lower, the yield on banks' asset may also decline mainly due to the increased competition in mortgage loans and flight to safety to investment grade assets. The impact will further compress banks' net interest margin and profitability.

The crux of the matter is that length of the crisis and the depth of its severity is still unknown both locally and globally. In the end, actions taken by regulators are meant to be temporary facilitative measures. While regulators will not suspend the measures overnight or without due warning, banks should be planning ahead for a return to normality. They should also be preparing for any adjustment to a new normal – we expect that regulators will be taking stock of what worked, and what did not, during this crisis. Banks can expect a certain amount of adjustment following the crisis as regulators fine-tune their approach and requirements on financial stability. 

How Deloitte can help

Deloitte is committed to help our clients to steer through challenges both during and post COVID-19. For example, we can help to perform a rapid impact assessment, conduct stress testing exercise on existing models, and develop capital management strategy in order to respond to new regulatory measures and to seize opportunities amidst the global pandemic. 

Our international expertise and experience with financial risk management enable us to support clients with a broad range of services, tools and methodologies, allowing you to response quickly and thrive in the COVID-19 environment. Our tailored services include:

• Prepare scenario planning and stress testing exercises that closely reflect the less favorable economic outlook;
• Develop dynamic cash forecasting and calculations for managing cash flows and estimating financial covenant compliance;
• Assist with the design and development of a strategy to effectively utilise liquidity buffers;
• Assist to formulate a financing support request to existing shareholders, leveraging on our past project experience to accelerate the process and maximize the chances of success;
• Leverage on the knowledge of our subject matter experts across our extensive network to develop credit solutions term sheet with appropriate terms, conditions and costs to support rapid capital raising.

Deloitte's approach takes all of the components required to deliver a client outreach project, and wraps them up together as a single service. We are committed to help banks to turnaround, transform and grow their businesses and to navigate the financial impact of COVID-19.