COVID-19 related strategic scenario design and financial impact assessment for banks - Banking blog

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This article forms part in a series on the impact of COVID-19 on the Swiss banking industry. Deloitte will be publishing on an ongoing basis its perspectives on key implications and potential solutions that banks should consider.

Introduction

The negative effects on the Swiss economy triggered by the COVID-19 crisis are becoming increasingly visible as well as consistently worse. Based on latest SECO forecasts, Swiss GDP for now is expected to decline by 6.7% this year and the recession most likely will last into 2021.

The government has taken strong pro-active measures to support selectively the suffering economy. These include amongst others the supply of temporary liquidity loans to SMEs totalling CHF 40bn (equal to over 5% of Swiss GDP) and temporary FINMA exemptions for banks.

From our analysis of relevant COVID-19 scenarios, however, we still see significant risks for Swiss banks in the current situation with potentially severe short- and mid-term impacts on their P&L, balance sheet and capital position. Assuming an economic downturn that follows an “L-Scenario”, we have simulated that corporate default rates on average may increase to over 3% (i.e. five times above the historical average). In addition, from our work as auditor and advisor to Swiss banks, we already see the financial impact coming through with an increase in the rate of credit write-downs. Hence, the current situation requires an immediate response from bank executives:

  1. Drive your COVID-19 scenario design and detailing: Develop a common understanding within the bank on how the corridor of relevant COVID-19 scenarios may materialise;
  2. Understand the impact on your profitability, capital and liquidity position: Translate the COVID-19 scenarios into a simulation of relevant impacts on key KPI’s of your bank;
  3. Define and take pro-active measures: Understand which actions already shall be implemented today to buffer and counter the effects of short- and mid-term adverse developments.

In this regard, Deloitte (i) has developed a detailed view on relevant scenarios for the current crisis, (ii) has a proven tool set at hand to give support to managing the situation and (iii) is able to define action plans to mitigate the risks and help Swiss banks to navigate successfully through this crisis.

Understanding the crisis

In comparison to other crises in the past, the current COVID-19 crisis is unique given its simultaneous shock to the supply and the demand side of the economy alike. Hence, expected severity of the crisis meanwhile is compared to what the Swiss economy experienced during the first oil crisis in the mid-1970s.

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For banks, it will be key in a first step to drive their strategic scenario views on how the crisis may materialise in the short- to mid-term future. Here, it is of major importance not to limit the analysis to a national, i.e. Swiss level, but to consider also industry- and sector- as well as larger regional levels. For example, while the pharmaceutical sector in the Basel region may even profit from the development of antibody tests or a vaccine against SARS-CoV-2, the tourism sector in the Grisons and Valais regions will have to cope with a substantial reduction in bookings.

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Understanding the impact of the crisis

In a second step, banks need to translate their strategic scenario views into a tangible measurement of the likely impact on their P&L, balance sheet and capital position. This can be done for example by means of a comprehensive loan book analysis with a focus on identifying concentrations of exposures on their balance sheets to (i) single names, (ii) industries/sectors and (iii) regions.

Our analysis shows that under currently prevailing macro-economic forecasts for 2020 and 2021, positive operating results of locally operating Swiss banks are at risk and may turn negative, predominantly due to reduced interest earnings and an increase in provisions and loan losses.

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Relevant measures to navigate through the crisis

As a final step, banks may define a set of core KPIs for target setting, monitoring and active management in order to navigate successfully through the crisis and to ensure for continuously positive operating results. From our perspective these core KPIs shall focus on banks’:

  • Overall performance attributes;
  • Regulatory adequacy position;
  • Lending and credit risk characteristics;
  • Assets under management (AuM);
  • Operational soundness.

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To manage this set of KPIs successfully, we have identified seven mitigation solutions that we consider best suited for helping banks navigate through the current crisis.

As per the above, we propose banks in a first instance to gain full transparency on their scenario views and to perform a comprehensive loan book review to derive relevant insights into potential impacts on their balance sheets. Further, mitigation solutions shall focus on stabilising and securing banks’ profitability, capital and liquidity positions. In a last step, mitigation solutions shall prepare the banks for the post-crisis world. An emergency task force within banks may be set-up, serving as the relevant authority to coordinate and steer the previously defined mitigation solutions overall.

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Conclusion

At Deloitte, we believe that even though the Swiss government has already taken action to ease the lockdown restrictions, the peak of the economic downturn is still to come. The effective proactive measures taken – in particular the granting of temporary liquidity loans to SMEs totalling CHF40bn – have for the time being successfully averted an immediate crash of the Swiss economy. However, we expect economic activity to remain at low levels in the coming months and that corporate default rates (in particular in the SME space) will start to increase in Q3 and Q4 of 2020 accordingly. Hence, it is now time for banks to prepare and to (i) gain transparency about the scenarios that might possibly occur (ii) identify their respective impacts on their financial position and (iii) define pro-active mitigation solutions to navigate successfully through the crisis in the coming months.

We hope this short document will help you in taking appropriate steps toward developing a suitable modus operandi for your bank. Should you have any questions, we will of course be more than happy to share our experiences and insights with you further.

COVID-19 banking blog series

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Marc Grueter - Partner, Risk and Regulation

Marc is a Partner in Deloitte’s Risk Advisory practice and a member of the Financial Services leadership team at Deloitte in Switzerland. Within Deloitte Switzerland he is in charge of Risk, Regulatory, Compliance and Transformation topics for Financial Services. Marc holds a PhD degree in Bank Management, Finance, Risk & Regulatory Management from the University of Basel. He has over 18 years of experience in the global Financial Services sector, as well as a solid background in Strategy and Management which he gained from working at a number of leading global Consulting firms.

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Florian Munz - Senior Manager, FS Transformation

Florian has over fourteen years’ experience in the areas of strategy, finance, risk and regulation for financial services companies. With his project portfolio, he focuses on –
- AQRs, comprehensive loan book reviews, (regulatory) stress testing exercises and scenario modelling;
- Large-scale regulatory transformation initiatives in cooperation with supervisory authorities;
- Strategic transformation initiatives of the CRO Function towards increased effectiveness and efficiency.

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Eric Gutzwiller - Senior Manager, FS Transformation

Eric has over seven years’ experience in the areas of strategy, finance and risk for financial services companies. With his project portfolio, he focuses on –
- Comprehensive financial market stress tests;
- Loan loss provisioning process optimization as well as end-to-end credit process optimization and digitization;
- Complex re-organisations and comprehensive cost optimization initiatives of banks.

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Patrick Menz - Assistant Manager, FS Transformation

Patrick has over four years’ experience in the areas of strategy, finance and risk for financial services companies. With his project portfolio, he focuses on –
- Strategic transformation initiatives of the CRO Function towards increased effectiveness and efficiency;
- Complex re-organisations and comprehensive cost optimisation initiatives of banks;
- Corporate and Retail Banking strategy development and implementation.

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