Coronavirus could impact banks' staffing, exposures and capital rules

Banks’ operations, exposures and potentially their capital rules could all be affected by the worldwide spread of the Covid-19 virus, even as global regulators insist the fundamentals of financial stability remain sound.

The unexpectedly broad spread of the coronavirus variant, which first took hold in mainland China, and the risk of lockdowns affecting the economy have cast an understandable pall over markets, prompting the biggest fall in equity prices since the 2011 euro crisis.

In turn, there will clearly be many impacts on banking, starting with the operational impact on institutions and regulators of a lockdown, in which their workers are urged to stay at home.

Lockdown

The European Central Bank today said it would cancel conferences and non-essential staff travel; banks can also probably expect fewer site visits from supervisory teams.

If coronavirus cases are confirmed, banks may decide to send staff home, including those on core functions like the trading desk. But then they will face a slew of questions, such as whether EU data, cybersecurity and financial trading laws allow employees to do their jobs effectively away from the main site.

UK regulators at the Bank of England have this issue on their radar.

Supervisors are reviewing contingency plans, “including assessments of operational risks and the ability of these firms to serve customers and markets with split teams and remote working,” Governor Mark Carney pledged on Tuesday, telling lawmakers that his staff were in “daily, hourly” contact with major institutions.

Carney said any policy response from central banks and financial supervisors will be “powerful and timely.” His colleagues at the Financial Conduct Authority today urged institutions to brush up on their crisis planning.

But the UK government warned in its Tuesday action plan that up to one-fifth of UK employees could end up absent from work when infections reach their peak. With so much of the workforce out of action in Europe’s largest financial center, it remains to be seen how firms could continue to serve customers — and even how regulators could continue to oversee them.

Instability

Global regulators say that so far, markets are doing what they do best — predicting and providing for risk — and that the risk of a disorderly crash remains small. Banks are better prepared for a crisis than they were in 2008, they say.

“For all the turmoil and anxiety, both market functioning and financial intermediation more generally proved resilient,” Claudio Borio, head of the monetary and economic department at the Bank for International Settlements, said in remarks to journalists published Sunday.

Yet any economic downturn can trigger financial-stability issues. Already, the two parts of Europe potentially most affected — Germany, heavily exposed to trade with China, and Italy, where 2,500 Covid-19 cases have been confirmed — correspond to the weakest parts of the continent’s banking sector.

The OECD has issued a stark warning that the global economy is facing its “gravest threat” since the 2008 financial crisis and that the spread of the coronavirus could halve its global-growth outlook.

In principle, banking supervisors have fine-grained data about banking exposures that will allow them to monitor those impacts.

But orderly management requires financial and real-economy businesses to be upfront about exposures; the French financial market authority last week warned them they risk breaching EU market-abuse rules if they withhold information about the impact of the virus.

Capital

The final possible impact is regulatory forbearance.

Many small businesses will be affected by a loss of revenues during the crisis. If they have outstanding loans, there seems likely to be, at the very least, political pressure on banks not to foreclose in a time of need.

That could in turn require regulators to show some flexibility over the capital requirements imposed on sour loans.

Finance ministers from the Group of Seven leading economies yesterday said they were prepared to consider tax relief to aid those affected by the crisis; bank capital relaxations might in time prove to be one of the other “appropriate policy tools” they consider.

Supervisors normally expect banks to prepare contingency plans against a range of scenarios, and would expect a pandemic to be one of them. Outbreaks of disease are, after all, a recurring and foreseeable event, even if their exact dynamics cannot be predicted.

Banks argue that they are well used to preparing for contingencies; the financial system exists as a shock absorber for the economy, and this is just another kind of shock.

Their supervisors argue this is exactly what stress tests are for. Although this exact scenario hasn’t been forecast, UK banks have shown their resilience to an economic downturn, coupled with a fall in GDP in China and Hong Kong, in the most recent stress test.

But now the effectiveness of those plans will be put to the test; it is only when the tide goes out that you see who was swimming naked.