Challenges for financial institutions during Covid-19 crisis

A majority of the world is currently being ravaged by the coronavirus outbreak. The effects of the ongoing coronavirus (Covid-19) crisis are being felt in almost every sector. This pandemic has revealed many weaknesses in the global system.

Every sector is being impacted differently and is facing its unique challenges. This virus has taken the world into a state of emergency. The economy is losing its balance.

Governments have already reacted and offered rescue packages for those in urgent need. Despite our accumulated experience in crisis management, this virus has been able to isolate us in all our homes.  

The big question is that once we are past this period, will the world go back to the way it was before or remain the same? It may be that everything will be different and we may witness a true restructuring of the global system.  

Fighting coronavirus pandemic is much larger than handling the danger of the death threat. The extent of death tolls and the economic and financial losses are uncertain. While the outcome of the global efforts and the potential timeline for handling the situation is unclear, there are clear indications that the resulting economic devastation might even bring greater havoc.

Economic activities are already severely disrupted in many countries, and others are getting ready to face the disruption. Alongside fighting with the virus, global economies are also started preparing for the following economic recession and crisis. The economic turbulence would certainly be causing huge challenges for the banking and financial industry.

This time it is a global economic crisis rather than a financial crisis. Global economic crisis is different in many ways from the financial crisis the world has faced earlier. It invites inflation, recession, unemployment and different types of hazards in the economic and social life of the inhabitants of the world and requires long term strategic management to sustain a normal life again.

Life is the keyword here not the livelihood. If life remains there will be livelihood. Human can rise from the ashes as the Earth has seen it before. On the other hand, the relationship between life and livelihood is inseparable, one cannot be thought of without the other. So, the big challenge is being able to balance life and livelihood and adopt the right, timely and realistic desired strategy.   

Financial institutions are facing the challenge of maintaining their normal activities. After all, the financial sector is heavily affected by the measures taken against the spread of the coronavirus. Departments and branches are temporarily working from home, which is unprecedented event in the history of the financial industry. Many internal and external services are being offered online.

The necessity and urgency of digital transformation, especially in financial institutions, becomes more than obvious in the current situation. The logical consequence is to reduce dependence on the branch by quickly extending the digitally available services. It has become a challenge to the Industry to offer these online services effectively and efficiently to the customers.

The challenges may be faced by the banks and financial institutions in this coronavirus  era are as follows:

1.    Deterioration in the asset quality:

The main strength of the NBFIs is quality asset. Asset quality may be deteriorated in this crisis period as the repayment of the regular credits can be affected for various reasons, industry wise impact of the crisis, recession, opportunist borrowers etc. It is likely to occur in the asset quality, the bank and NBFIs to finance or invest businesses without applying more Credit Risk Management tools in the changed scenario. It may create havoc in the industry with a rush to get finances irrationally. Businesses who are not in need or who have the power to get it,  will get it and not be able to repay in time,  like usual. Other than the wilful defaulter, the regular customer will not be able to repay the loan despite their good intension, due to the impact of COVID-19 on their respective business.  

2.    Decrease in overall net income and profitability:

As the crisis is going to hit the asset side of the financial institutions, it is obvious that it will create a decrease in the Net Income and Profitability. No financial institution shall be immune to this fact. Besides, previously imposed regulatory bar for the interest rate will also have adverse effects. Cost of fund is going to be high and the spread would go down, other contingency income will also be very limited.  

3.    Asset liability mismatch or gap in net cash flow as liquidity crisis:

There shall be a terrible gap between asset and liability products duration and maturity. As the asset products are long term based and the liability products are generally short term,  in this crisis period, it would be very uncertain from the depositor's point of view. Many retail depositors shall liquidate their deposit if the crisis remains.

4.    Equity/ Capital erosion as an impact of decrease in net income:

Dividend sustainability of a financial institution essentially comes down to two things: net income and capital adequacy. They need a certain level of capital to remain well capitalised and a certain level of net income to maintain dividend payments. Credit losses can eat away at capital levels, presenting a severe risk to dividend sustainability. If capital is depleted the FI will need to use its net income to rebuild capital, potentially putting dividend sustainability at risk. Net income is used to fund the dividends, so lower-income, even without credit losses, also puts a strain on funding the dividend. If the FI suffers lower net income and big hits to capital levels, it will create a  double strain because it has to use a more limited net income stream to first fund its capital and there isn't as much left over for a dividend. Any dividend pay-out that exceeds net income will reduce capital over time.

As we know, the government and Central Bank have injected large sums for the banking sector and offered unprecedented exemptions that were not provided before. Bangladesh Bank has already issued several circulars like interest rate rebate or subsidy, re-finance facilities, etc. for those affected by the global crisis, it would not help the financial institutions much as they borrow money from the banks to support their activities.

NBFIs shall be in a dire need to have quick liquidity support from the Bangladesh Bank, unlike the banking sector. For this, the Bangladesh Bank may issue Pre-Finances that would help the NBFIs from suffocation. Special facility and priority should be given to the NBFIs while considering these pre-finances. The central bank may create a pool of fund to support NBFI's term loan facilities that would suffer from this pandemic. The Bangladesh Bank may order all the Banks not to withdraw deposits from the NBFIs for a considerable amount of time.

Bangladesh Leasing and Finance Companies Association (BLFCA) have already requested the Bangladesh Bank to constitute a fund of Tk 10,000 Crore as 'Special Drawing Limit' for the NBFIs with interest rate equivalent to prevailing bank rate to face the ongoing liquidity crisis in the NBFI sector. They also requested for the reduction of CRR and SLR requirement of NBFIs, to be brought down by 1 percent each keeping in line with the reduction of CRR and SLR of Commercial Banks. Besides, BLFCA also appealed to Bangladesh Bank to exercise their offices not to encash the deposit of schedule banks maintaining with FIs, to restructure the term loans due to the severe impact of the Covid-19.

BLFCA also submitted that any bailout package declared by the government channeled through BB should include NBFIS along with commercial banks to ensure that the affected clients of NBFIs also receive required subsidy/stimulus to withstand the adverse situation.

Since the NBFIs are contributing widely and immensely in the economic development of the country and are going to face serious liquidity shortfall, it's time for competent authority to look into the matter seriously with a positive attitude and save the sector in the greater interest of the nation.      

The global pandemic has been the event of a lifetime. It has affected humankind on an economic and social scale. The only way out of this situation is through unity and that is a long term approach. Our hope should be to return to a healthy and beautiful world once again.

The author is Managing Director and CEO, Islamic Finance and Investment Limited (IFIL).