COVID-19 and banks – Road to recovery
By Khoo Siew Kiat, Restructuring Services Leader of Deloitte Malaysia
KUALA LUMPUR, 23 June 2021 - The COVID-19 pandemic has negatively impacted almost all real sectors, yet some like tourism and hospitality, aviation, retail and real estate, are worse hit than others. As the pandemic continues to wreak havoc on the economy and with the country in its third movement control order, the banking industry needs to continue to adapt and change.
Recovery is expected in the future with the ongoing vaccine roll out. However, it remains to be seen how soon will recovery begin, and to what extent recovery of profitability to pre-COVID times can be achieved. With the Overnight Policy Rate (OPR) remaining at 1.75% since July last year, interest income remains compressed as banks continue to take measures to comply with Bank Negara Malaysia (BNM)’s call to assist borrowers, based on their specific financial circumstances even after the expiration of previous moratoriums.
In general, Malaysian banks are well capitalised with low non-performing loan (NPL) levels, credit costs, and sufficient capital buffers. However, NPL ratios are expected to increase once the moratorium or targeted repayment assistance for borrowers come to an end, driven by SMEs and retail customers. The risk of higher loan defaults puts further pressure on the profitability of banks. Although Malaysian banks have made additional loan loss provisions to deal with deteriorating loan asset quality, the full extent of the consequences of the pandemic-induced credit risk has yet to emerge.
Lessons learnt from previous crises tell us that banks that take bold and difficult decision early, to deal with issues quickly and decisively will recover and thrive ahead of their peer groups. Banks looking to navigate the market uncertainty to both survive and thrive in this new normal, will do well by looking at immediate actions it can take to avoid long-term negative consequences of the pandemic. These strategies should not distract banks from conducting or operating its core business, but be deployed with tightened operational alignment, together with the help of in-house talent and professional advisors with various skillsets.
Non-Core Asset Portfolio Disposals
A portfolio sale is the most direct way to reduce headline NPL ratios and provides certainty of an early cash receipt. It also frees up capital to be deployed to other more profitable business units that have scale and technology to thrive post pandemic. It can result in cost savings as fewer resources are required to manage time intensive work out positions. Mature markets such as in Europe have seen portfolio sales as a successful tool to deleverage their balance sheets, with more than $850bn portfolio transactions over the last five years! However in Malaysia, NPL sales have been sporadic over the past couple of years, in comparison to our neighbouring countries due to the stringent requirements and approvals required by the central bank, before a transaction can be completed.
As the Malaysian market waits for BNM to re-look into NPL guidelines, banks can prepare for future portfolio sales by conducting data integrity checks, data preparation and remediation, loan portfolio diagnostics, indicative pricing exercises, and preparation for the overall transaction process.
Strategic Asset Quality Reviews
Banks are expected to experience deteriorating loan books and higher IFRS 9 Financial Instruments adjustments as credit delinquencies surge across most sectors, damaging financial results. The need for updated internal risk assessment and mitigation models is more pressing, now than ever, and strategic asset quality reviews can lead to opportunities arising from liquidity and working capital shortfalls of customers. Banks can consider loan portfolio diagnostics, early warning and risk mitigation plan preparation, scenario and cash flow stress modelling and impairment assessment to address these issues.
Optimising the Balance Sheet
Despite regulatory forbearance, capital ratios are expected to deteriorate due to credit quality reductions, risk-weighted asset (RWA) increases and profit & loss (P&L) losses. This can result in relative under-performers being penalised by the market and agencies. Banks need to identify mitigating actions to continually optimise its balance sheet, such as identification of short-to-medium term capital-accretive actions, reassessment of capital targets or performance benchmarking, strategic capital allocation, and proactive outreach strategy to key stakeholders (i.e. regulators, rating agencies and investors).
Non-Core Asset Management
Previous crises have shown that running a focused non-core asset management unit which is established to specifically undertake high volume sale and wind down activities, have proven successful. It has become a popular approach globally, allowing existing management to focus on core activities, and at the same time provide the right skills and resources to develop and execute an appropriate deleveraging strategy for the non-core activities.
Separating good and bad assets of the bank is key when managing non-core assets. Banks must decide if the “good bank” and “bad bank” can be separated in-house or through full legal separation such as a “bad bank” setup (typically structured as asset management companies or special purpose vehicles). The difference between an in-house and full legal separation results in management and financial reporting differences. While a “bad bank” is complex to set up, a structured solution provides a strong message to the market, maximises the transfer of risk, facilitates straightforward portfolio sales, and therefore makes rapid deleveraging simple. The “good bank” in turn is insulated, enabling it to recover from the crises and thrive by focusing on driving performance of profitable business units.
Finally, banks can consider developing or executing de-risking programs to reinforce its balance sheet and capital base as surges in non-core and non-productive assets result in larger capital burden. With IFRS 9 in place, higher impairments and rising loan delinquencies may also penalise operating results. Analysis of strategic deleveraging options, credit risk management, capital or RWA optimisation, and portfolio optimisation are a few examples of the strategies that banks can implement.
At the end of the day, regardless of the strategies employed, banks that take a more proactive approach will remain ahead of its peers, and consequently be on the right track toward recovery.
The views and opinions expressed in this article are those of Khoo Siew Kiat, Restructuring Services Leader of Deloitte Malaysia.
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