- Credit misallocation causing lasting risks to economies, and needs course-correction
- Bankruptcy frameworks need to prepare for potential impact of credit losses on banking systems
- Authorities need to be ready to support institutions that will remain weak despite use of capital buffers and forbearance
The Global Financial Crisis of 2009 was called the “Credit Crisis” – but what we are facing now will be the “Real Credit Crisis” of our time, according to a new report by management consultancy Oliver Wyman.
Titled, The Real Credit Crisis: How Governments and Financial Services Can Work Together to Speed Economic Recovery, the new report looks at how the global economy is going to emerge from this crisis in desperate need of growth. Public authorities will need to work with the financial services system to speed the economic recovery. Banks’ expertise in restructuring will become increasingly important, as well as their critical function in traded debt and other financial markets.
Many households and companies, already highly leveraged, are taking on more debt; a situation in which many firms across industry sectors are unlikely to be able to sustain this debt. Governments and the financial system need to work together to absorb some of the financial losses, keep businesses alive, and help speed the economic recovery.
Mathieu Vasseux, Head of Financial Services at Oliver Wyman (MEA), said: “The 2009 Financial Crisis had a very limited effect on the GCC given its banking system had limited exposure to subprime lending and hence was largely insulated from the Credit Crisis.
The current crisis will be the opposite – the GCC will be more affected than the rest of the world. The GCC is impacted by COVID-19 like other countries, but on top of COVID the economic impact on GCC is compounded by the 60% drop in oil price. This will cause credit and solvency of corporates to be impacted more heavily.”
To support the growth needed to emerge from the crisis, authorities must acknowledge the crucial role banks can play and take the below actions:
· Course-correct on credit provision to small and midsized businesses: Much of the lending stimulus today is not getting to the right businesses. Fixing this requires an assessment of credit availability and the operational capacity of the banking system and finding fast solutions. When necessary, authorities must simplify existing measures or extend their scope to address blind spots.
· Prepare to manage a potentially large corporate solvency crisis that will arise after the initial liquidity support: Authorities will need to assess the preparedness of their bankruptcy systems and the potential impact of credit losses on their banking systems, and make strategic decisions on how and where to stimulate equity capital support to troubled businesses that can drive future growth. New restructuring vehicles are likely to be required.
· Prepare to intervene in parts of the financial system as second-order financial stability issues arise. Good decisions have been made on the use of capital buffers and forbearance. But the risks are rising that some financial institutions will remain structurally weak or even fail. Authorities will need to be ready for intervention. Resolution planning efforts carried out in the last 10 years may come to a real test for the first time in several countries.
· Planning loss absorption for future outbreaks. Systemic risks are rising relative to diversifiable risks, and this means greater government steering of loss absorption is here to stay and needs planning. Specifically, to stimulate confidence in the right growth credit and capital now, we believe a better-designed sharing of loss absorption between government, business, investors, banks, and insurers is required. The urgent priority today is to put in place a systemic solution to pandemic re-insurance.
Oliver Wyman believes the global economic impact of the COVID-19 outbreak depends on its duration, how far it spreads and the extent quarantine disrupts the labour market.