Financial service providers should not ignore the risk of loan defaults – Part 2 - Banking blog

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This is the second part of our blog series on the impact of the COVID-19 crisis on Swiss banks and the increased risk of loan defaults. Read the first part here.

How banks have reacted to the increased risk of loan defaults – and how to increase resilience

Initial reactions from banks

The most recent trends in the provision banks make for loan defaults reflect their concern about the rising risk of defaults.

The two major Swiss banks, for example, increased their provisions by 600% and 775% respectively in Q1 2020 compared with Q1 2019. These figures are a clear indication that Swiss banks recognise the threat of loan defaults and appear to be taking the risk seriously.

Looking at nominal increases in default provision alone paints an incomplete picture, however. Another aspect of the banks’ resilience during the crisis is the ratio between provision for defaults and the total volume of credit claims. The statistics show a clear upward trend, but it is also evident that the two major Swiss banks had loan default provisions averaging just 0.11% of credit claims throughout H1 2020. The major European banks had much higher default provision over the same period, at an average of 0.34% of credit claims.

A further comparison, with the US, reveals a familiar pattern: Swiss and European banks tend to react much less stringently than their US competitors to crises and the threat of loan defaults. Major US banks made new provisions for defaults averaging 0.79% of their outstanding credit claims in H1 2020, for example, more than twice that of their European counterparts and seven times that of the two major Swiss banks.

Chart 3. Provision for loan defaults – international comparison

image from blogs.deloitte.ch

Historical trends in provision for loan defaults as a percentage of outstanding credit claims. Selected major Swiss, European and US banks. Source: bank reporting; Deloitte 2020.

However, Switzerland’s major banks have traditionally run markedly more conservative loan books than their European and US counterparts. But it remains to be seen whether the relatively low level of new default provision from H1 2020 will be enough to completely cushion the loan defaults that can now be expected.

Chart 3 also shows that competitors from all three regions took their provisions back down to pre-crisis levels during Q3 2020. This was probably the result of the comparatively positive summer months following a let-up in the pandemic, with economies able to mount a recovery, with surprisingly good figures.

However, both, economic growth and the trajectory of the pandemic have deteriorated again over the past couple of months in Europe and the US and, as noted above, several market observers now expect a wave of insolvencies from November. Mass vaccination will not be available before 2021 – and there is already evidence of loan defaults in the Swiss market, although they are for now isolated instances.

Banks need to be crisis-proof

To sum up, although economic forecasts continue to be very uncertain, and despite the fact that the banks are well prepared in general terms, the financial services sector must boost its resilience even more. It is important that banks in Switzerland optimise their capitalisation monitoring. As the Deloitte study A stress event like no other argues, their current priorities should include:

  • strategic planning for a deterioration in capitalisation
  • measures to increase risk-weighted capitalisation
  • improvements in their business and technology platforms to enable them to manage volatile and challenging market conditions as smoothly as possible
  • transformation measures to boost profitability in the long term and prepare for post-crisis growth opportunities
  • regular exchanges with regulatory bodies and market players.

They should also be analysing the robustness of their existing loan portfolio, not least against the backdrop of negative scenarios such as a long-term economic crisis and a decline in the effectiveness of Federal Council crisis measures. Medium and long-term issues will also need to include loan pricing: realistic credit risks need to be factored into pricing, and the cost of loans cannot be geared largely to market rates. Even if defaults remain on a small scale – as the sector very much hopes – a more difficult economic environment is likely to demonstrate how important it is to factor in loan defaults.

It is not merely in the banks’ own interests to bolster their precautions against a credit and financial crisis. The 2008 financial crisis demonstrated that such crises spill over into the economy as a whole: tax revenues fall, unemployment rises, credit may become less readily available, and investment is hampered. It is crucial that Switzerland avoids another financial crisis, especially against the backdrop of the COVID-19 pandemic, and the banks need to play their part, for example by administering coronavirus loans. In addition, they must be sufficiently crisis-proof to be able to manage an increase in loan defaults, in case that is just what happens.

Many thanks to Marco Kaeser for his valuable input to this article. Please reach out to our authors for any questions.

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Marc Grueter - Partner, Risk Advisory

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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Florain Munz

Florian Munz - Senior Manager, Risk Advisory

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; and strategic transformation initiatives of the CRO Function towards increased effectiveness and efficiency.

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Eric

Eric Gutzwiller - Senior Manager, Risk Advisory

Eric is a Senior Manager at Deloitte for the Financial Services industry, especially focused on leading process optimization and digitalization as well as strategic TOM design projects in credit and credit risk management (Mortgage, Lombard, Corporate, SME, Consumer lending), Finance and Risk. He brings over 8 years of strategy consulting experience for both, globally leading institutions and developing players, as well as central banks and regulators, in several established (Switzerland, UK, US, Hong-Kong, Germany) and also emerging markets (CEE, Middle East).

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Dennis

Dennis Brandes - Manager, Research

Dennis is a Research Manager at Deloitte Insight Switzerland in Zurich, specializing on the Swiss economy, the Swiss CFO Survey and the financial services industry. He joined Deloitte in December 2010 after 5 years in the research department of one of the largest Swiss banks, where he had focused on the international aspects of the Swiss economy. Dennis holds a Master Degree in Economics from the University of Basel.

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