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Impact of COVID-19 on credit portfolios of banks

  • Matthias Degen, Partner |

COVID-19 is having far-reaching consequences for the global economy. Financial markets everywhere are experiencing a historic crunch and further global financial and economic crises are looming large. Banks are being forced to react in various areas – among others, in liquidity risk management to prevent bottlenecks.

One of the most important aspects from a risk management perspective is a detailed analysis of COVID-19 effects on the credit portfolio. It is presumed that commercial credit customers will soon become increasingly insolvent. Bloomberg for instance reported that half of all listed retail companies in China could collapse. Italy has ordered the closure of all "non-essential" companies and factories, which means that there will be large income gaps; Ticino is also closing down industrial plants. While authorities around the world are in the process of cushioning these effects with a range of countermeasures, it is nevertheless expected that the global economy will experience a further crunch in the coming weeks, Switzerland included. As a result, private client loans may also be affected if the crisis continues to spread to private investment portfolios or mortgages. Significant value adjustments could be imminent.

Impact on capital position

In response to the COVID-19 crisis, FINMA has granted various temporary exemptions, for instance, relating to the calculation of the leverage ratio or risk diversification requirements (see FINMA Guidance 02/2020, 31 March 2020). Despite this, expect two direct effects on banks’ capital situation. Firstly, value adjustments will have a direct impact on the eligible capital. Secondly, an increase in default risk or downgrades of ratings will result in higher risk weights for credit exposures. As a consequence, more capital must be held. Both effects will lead to a lower capital ratio and, in extreme cases, to insufficient (regulatory) capital.

Problematic loans will affect P&L and capital with a certain time lag. Expect initial collateral shortfalls for Lombard loans as stock prices crumble further. It is likely that you will identify impaired corporate loans shortly, with mortgage loans at risk to follow. The sooner you have good analytics in place for your own loan portfolio, the more proactive and targeted your reaction will be.

Analyses and simulations in the loan portfolio review

A special feature of the current crisis is its abrupt occurrence with unforeseeable developments on an unimagined scale. Banks are confronted with a completely new market situation practically overnight. Existing risk analyses of credit risks, expected loss, PD and LGD calibrations have been outdated abruptly.

It is now imperative to reassess the risk situation as soon as possible in order to better anticipate market developments and to be able to react appropriately to the crisis. A systematic credit portfolio review, including possible scenarios of further developments, is therefore highly recommended, if not even mandatory. Meaningful market parameters must be determined, which can be varied when simulating possible scenarios. In the best case, the scenarios can be adjusted at a later point in time to take into account the latest developments.

A credit portfolio review will identify credit exposures based on their risk exposure, recognizing where action is required. In particular, however, the review should enable the identification of risk concentrations from an overall portfolio perspective, whereby various dimensions can be considered, including sectoral and geographical concentrations of loans and collateral. Appropriate proactive measures are then defined on the basis of this analysis.

It is highly likely that senior governance committees (in particular the Executive Board and the Board of Directors), in addition to the Risk Committee and the supervisory authorities will place a greater focus on the loan portfolio analysis soon. It is therefore all the more important to be ready to present a robust analysis and a clear strategy for action.

Suitable countermeasures to the rescue

A credit portfolio review identifies impaired credit exposures and risk concentrations. The aim is to address material risks in a timely and focused manner and derive appropriate measures such as:

  • Identification of risk criteria and risk exposures
  • Identification and close monitoring of impaired credit exposures, with potential workout solutions determined:
  • Monitoring of risk concentrations, for example, sectoral concentrations in collateral
  • Monitoring of risk drivers
  • Determination of internal and external communication for example of to clients, client advisors, senior management committees and supervisors.

Also, read our Factsheet: Understanding the impact of COVID-19 (PDF)

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