Coronavirus may create credit squeeze

Credit losses to double in 2020, with disrupted global financial markets weakening banks' ability to meet demand

Coronavirus may create credit squeeze


By Madison Utley

New analysis has found that Australian banks should be able to absorb the increase in credit losses and disruption to funding markets due to the COVID-19 outbreak – as long as the duration and severity of the pandemic’s impact are in line with expectations.

According to S&P Global Ratings, a longer lasting and more severe impact than its revised base case could trigger significant problems for the Australian banking system.

If the virus progresses on the predicted timeline, the group estimates that it will contribute to the Australian banks' credit losses nearly doubling in 2020 from historic lows in 2019 which, while significant, is low compared to what is expected in other countries.  

Additionally, Australian banks should be able to absorb these increased credit losses in spite of headwinds from low and declining interest rates, a likely further decrease in demand for credit, and continuing customer remediation costs.

The S&P Global analysis also found the banks are adequately placed to deal with a temporary disruption in their access to offshore wholesale funding, on which they “materially rely”.

However, a large part of the banks' offshore borrowings is short-term, the refinancing of which is more sensitive to financial market sentiment, with the banks having completed their wholesale term-funding only for this financial year.

If the COVID-19 outbreak fails to subside as forecasted, banks stand to suffer.

The report reads: “First, the Australian banks would be challenged in accessing offshore wholesale funding if the global financial markets remain dislocated or if the Australian economy significantly deteriorates. A prolonged disruption in that access is also likely to weaken the banks' ability to meet the demand for credit in the Australian economy.

“Second, a significant drop in economic activity--in conjunction with weak business and consumer confidence--could add to the triggers for a rapid rise in unemployment and a drop in property prices.

"We note that property prices in Sydney and Melbourne--the two most populous cities of Australia--have risen sharply in recent months following an orderly correction in the past two years. Consequently, we expect that such a scenario would likely result in a sharp rise in the banks' credit losses, well above those that we currently forecast, and significantly weaker earnings.”

The S&P Global analysis acknowledged that the major Australian banks have the capacity to issue covered bonds to supplement their funding if needed, and they possess a “good level” of liquid assets on their balance sheets. Further, they have access to the Reserve Bank of Australia's (RBA) Committed Liquidity Facility, which was set up following the global financial crisis to help Australian banks meet unforeseen liquidity needs. Lastly, a larger proportion of new savings is expected to accrue to the Australian banks as the impact of the outbreak continues and retail customers become more risk averse, all of which should partly offset the impact from a disruption in the Australian banks' access to offshore borrowings.

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