Building a resilient and sustainable banking sector post COVID-19
COVID-19 emerged as a black swan event that stifled the global economy. It has resulted in social isolation within countries, closed borders, loss of business, loss of employment, industry-wide shutdowns, and many more adverse economic effects.
Governments across the globe initiated fiscal and monetary stimulus programs to combat the damaging economic effects caused by the virus. Volatility in the financial markets will spike in the aftermath of the crisis, most likely due to the difficulty in estimating the extent of the economic damage caused by this global event, which is still unfolding.
The extent of the downturn could be felt over many years as suggested by pundits. This pandemic has revealed many weaknesses in the global system. Every sector is being impacted differently and is facing its unique challenges.
The economic turbulence has certainly caused huge challenges for the banking and financial industry. Also, businesses around the world are falling victims to the significant impact the COVID-19 has generated and are now feeling the consequences it is set to leave.
Prior to the pandemic, banks were even dealing with hurdles, for example; changing customer expectations, higher operating costs, and new technology, all within an evolving regulatory landscape.
The current crisis has added another challenge to the mix and the sector is starting to face the economic aftermath. Thus, banks must focus on two things to emerge successful post-COVID-19: Efficiency and Customer Retention.
COVID-19 and Ghana’s banking industry
Banks have come a long way enduring and surviving many crises. The economic downturn induced by the Covid-19 pandemic may provoke another banking crisis after that of 2017-2018. This comes on top of the combination of the past decade of persistently high non-performing loans, stricter regulations, and competition from shadow (unregulated) banks and new digital entrants that has challenged the traditional business model.
Recent survey revealed that branch net-work usage has decreased in favour of digital channels as Automated Teller Machine, Mobile and Internet banking usage have been accelerated by COVID-19.
The Covid-19 crisis comes at the end of a decade that has witnessed significant transformation in the banking industry through reforms in the areas of new corporate governance directives, injection of additional capital requirement, and the introduction of Basel II and III.
The Covid-19 pandemic has led to some relaxation of regulations concerning capital and liquidity requirements so as to free resources for lending. Banks are back at centre stage of the intermediation channel and may thus benefit relative to non-bank lenders. Yet, depending on the unfolding of the crisis and the design of public policies, banks may experience a substantial increase in credit risk in the medium term and a consequent drain of capital. Their future solvency very much depends on the extent to which fiscal policies are used now and on future growth prospects.
The business model of banking has been challenged by three developments. The first is ‘high non-performing loans’ in recent past. These high NPL ratios affected both capital and profitability of banking institutions, in particular those that were more reliant on matured transformation and net interest income. The second is ‘increased prudential requirements, regulatory scrutiny and heavy compliance costs’ in the wake of the 2017-2019 banking crisis by the Bank of Ghana. These rules have contributed significantly to enhancing the stability of the banking sector. The third development is the massive application of digital technologies and the emergence of new competitors such as Fintech companies. While these have improved the efficiency of universal banks and allowed new products and services, they have favoured the entry of new FinTech players in banking-related activities, competing with traditional bank business models– in particular in the area of payment systems in the rural settings.
COVID-RELATED CHALLENGES IN GHANA’S BANKING INDUSTRY
Deterioration in the asset quality
As a result of the coronavirus (COVID-19) pandemic, the economy came to a sudden halt. As a result, this would likely bring about high levels of non-performing loans (NPLs). High levels of NPLs are problematic because they impair bank balance sheets, depress credit growth, and delay economic recovery.
Continuously, high NPL ratios were a concern for Bank of Ghana as a regulator and supervisor during the 2015-2018 banking crisis, and the COVID-19 pandemic has the capacity to cause a re-emergence of the NPL problem. The main strength of the banks and specialised deposit taking institutions is the quality asset.
Asset quality may deteriorate 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. The impact of the COVID-19 on businesses may lead to businesses defaulting to repay their loans. This may create a havoc in the industry with a rush to get finances irrationally. Businesses which are not in need or which have the power to get it, will get it and not be able to repay in time, as usual. Other than the wilful defaulter, the regular customers might not be able to repay the loan despite their good intension, due to the impact of COVID-19 on their respective businesses. This will lead to further pressure on banks’ profitability and, in turn, cut costs. High default rates would continue to reduce banks’ net interest margins, but may help contain default by firms and preserve collateral values somewhat, thus mitigating the new increase of NPLs.
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 as well as other contingency income will also be very limited. Declined incomes and revenues mean that banks’ profitability would also decline. Reduced fee and trading income would impact negatively on net interest income. The combined effect of low business activities, higher impairment and possible operational and fair value losses may result in reduced profit levels and capital depletion.
Banks income generating activities has directly been affected by the pandemic; hence, pursuing long term expansionary strategies might not be a preferred way of growth under this crisis situation.
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. Reduced cash inflows from loan repayment may impact banks’ liquidity position, increased cash withdrawals by depositors to meet their own funding needs and flight to quality as customers may move their funds from banks is expected to be significantly impacted by the pandemic to banks less impacted.
Equity/ Capital erosion
Dividend sustainability of a banking institution essentially comes down to two things: net income and capital adequacy. The Bank of Ghana’s policy on non-payment of dividends was a step in the right direction to shore up the banks’ capital and reserves requirement in COVID-19 period. The Bank of Ghana has ordered banks and specialised Deposit-Taking Institutions (SDIs) to suspend the declaration and payment of dividends or distribution of any reserves to shareholders– to ensure that banks and SDIs are better able to support their customers throughout the COVID-19 pandemic, and to absorb any potential operational losses for banks and SDIs from the COVID-19 pandemic.
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 banks 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 Banks and SDIs suffer 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.
Regulation, policy, and financial stability Challenges
Notwithstanding the possible opportunities, the COVID-19 crisis has also brought to the fore risks that had been emerging prior to the pandemic. For instance, risks to financial stability— notably as regulatory arbitrage leads financial activities to migrate from the regulated to the less or lightly regulated sector— are one important concern of policymakers.
Financial service providers could be facing new money laundering/terrorism finance (ML/TF) risks. Regulators warn that cybersecurity risks or inappropriate lending practices by underregulated institutions could jeopardize trust. The balance of risks may also be affected by the possible changes in the fintech landscape and regulations during and post COVID-19.
Before Covid-19, one major challenge for banking was how to adapt to the reformed regulatory environment after the 2017-2019 banking crisis. Corporate governance directive, stricter capital and liquidity regulation has been effective in making the banking system more stable (Bank of Ghana 3rd Quarterly report 2019). Banks have increased their capital levels considerably since the banking crisis of 2017-2019. Banks with more capital have lower funding costs and tend to provide more credit. Nonetheless, this may not hold in the short run if banks are forced to comply with stricter capital regulation. The reason is that they may do so by adjusting the denominator of the capital ratio by limiting lending to reduce risk-weighted assets.
The digital disruption in banking raises regulatory issues in at least the following domains: micro-prudential, macroprudential and competition policy, consumer protection and data management.
Risk management challenges
COVID-19 might have a lasting effect on banks’ risk management strategy. The banking sector could experience changes in credit risk, market risk and operational risk as a consequence of COVID 19. It is inevitable that the credit quality in certain sectors will be negatively impacted due to the hibernation of the economy over the last number of months. This may result in a revised credit rating. With the turbulent financial market conditions of late, market risk has been an impacted area.
Banks might need to revise certain stress testing scenarios and methodologies for back-testing. The very nature of the day-to-day banking business requires that banks become experts at assessing and managing risks. Banks exist to take on the risk of their customer base and offer them hedging against cross-sectional risk, intertemporal risk and liquidity risk.
By offering its clients risk-management products, the bank itself absorbs an inventory of risk. The bank prices these products by estimating the costs of managing the risks inherent in each transaction. In doing so, banks themselves become exposed to numerous risks, ranging from interest rate risk, credit risk, currency risk and liquidity risk to operational risk (including, recently, money laundering risk and cyber risk).
From risk management perspective, the role of risk management is expected to increasingly become that of a business advisor focusing on the preservation of business value, rather than merely a control function. Ghanaian banks need to ensure readiness in case of crisis management with continuous development and updating of recovery options linked with liquidity position to ensure solvency.
Redundancy and lay-offs
One of the severe consequences of the pandemic relates to its damaging impact on the employment level of a country. Unemployment rate is closely related to the well-functioning of the economy. According to UNDP, World Bank and Ghana Statistical Services (08/2020) the COVID-19 has impacted negatively on Ghanaian labour force with banking sector in no exception. The shock caused by the COVID-19 pandemic has had considerable impacts on Ghanaian businesses, forcing many firms to cut costs by reducing staff hours, cutting wages, and in some cases laying off workers.
The banking sector is no exception to the reduction of staff working hours, cutting of wages, downsizing, right sizing and redundancies. This is according to results from a new COVID-19 Business Tracker Survey conducted by the Ghana Statistical Service (GSS), in collaboration with the United Nations Development Programme (UNDP), and the World Bank. The results show that about 770,000 workers (25.7% of the total workforce), had their wages reduced and about 42,000 employees were laid off during the country’s COVID-19 partial lockdown.
The pandemic also led to reduction in working hours for close to 700,000 workers. With digitalization and intensive use of information technology in the banking industry in the Post COVID-19, it could possibly result in downsizing, rightsizing and possible redundancies in the labour force in the sector.
Innovations resulting from technology and digitisation may therefore result in downsizing and redundancies in the banking industry.
Increased Cyber Attacks, Internet frauds and financial crimes
Financial institutions are facing a potential increase in cyber-attacks and fraud attempts due to the growth of digital banking interactions which is compounded due to employees working remotely from home/less secure environments. Cyber and Fraud, albeit, a key focus for the banking industry, will no doubt take centre stage.
The increased use of digital channels such as Automated Teller Machines, Mobile Apps and Internet banking could translate into increased cyber- attacks, financial crimes as well as internet banking frauds. The flip side of digital strategies is that the financial system has increased exposure to cyber risk due to ever-evolving cyber threats. Cyber risk imposes costs, not only for financial institutions, but also for their customers and the financial system as a whole. The pandemic has led to an increase in cyberattacks due to extensive use of financial institutions’ IT infrastructure, third-party and client-facing online services. Threat actors might also take advantage of the general panic and confusion. In this regard, financial institutions’ cyber resilience processes should remain vigilant in order to identify and protect vulnerable systems.
As earlier indicated, the COVID-19 crisis has also brought to the fore risks that had been emerging prior to the pandemic e.g. risks to financial stability.
The possible disruption of traditional business models, and the interconnectedness of traditional financial institutions with lightly supervised fintech companies raise similar concerns. There are also risks related to the technology itself, which affect both banks and nonbank financial institutions: for instance, confidential data may leak, including via cyberattacks. Financial service providers could be facing new money laundering/terrorism finance (ML/TF) risks.
Regulators warned that cybersecurity risks or inappropriate lending practices by underregulated institutions could jeopardize trust. The balance of risks may also be affected by the possible changes in the fintech landscape and regulations during and post COVID-19.
Financial inclusion itself could be at risk as digital services accelerate in the post-COVID era, driven by unequal access to digital infrastructure and potential biases amplified by new data sources and data analytics.
Digital Banking challenge
Many customers who were reluctant to engage digitally with their banks, have been ‘forced’ to do it during quarantine. As a result, banks have tripled their digital interactions with customers during this period. The main challenge now is to ensure that they can provide customers with all of the basic services digitally, end-to-end (Onboarding, lending etc.), which was not the case for many financial institutions pre-covid-19.
Business Continuity Issues
Banks have been compelled to adapt quickly during this pandemic, both internally and vis-à-vis their customers. Banks that heavily invested in digital transformation over recent years are now reaping the benefits and seeing the results of their investment. Despite cyber threats and a significant increase in digital interactions, keeping their systems stable and reliable is a key focus of banks.
POST COVID-19 OPPORTUNITIES
As is the case with most crises, while the current situation brings multiple challenges to the forefront, as described above, it also brings with it many opportunities for banks.
Firstly, digital transformation in banking sector will make more resilient and sustainable in the post Covid-19 era. The declining use of physical branches is likely, for many customers, to remain a permanent feature of their lives. The reality is, this is likely to accelerate a multi-decade trend we've already seen towards digitisation. So, when we look at the architecture of banking moving forward and the real elements that have been accelerated during the coronavirus period, you can see that that shift to digital is creating much more, aligned to some digital experience. This basically brings us to a new model of banking… we moved to this low friction banking embedded in the world around us. Digital transformation offers the right combination of solutions or tools delivered digitally to provide a seamless user experience. Ghanaian banks should take advantage of the opportunity the crisis presents to digitize their business models and operations.
However, banks need to customize and contextualize their strategies for digital transformation. They may need to develop unique, individual and customized digital solutions that move past the current limitations of using physical touchpoints.
Secondly, Ghanaian banks may have to intensify the use of Technology to make banking sector more resilient in post COVID-19 era. Technology is at the core of the banking business via ensuring productivity, innovativeness, fast transactions, real-time fund settlement etc. Technology makes banking smoother and seamless for users. Ghanaian banks are criticized for the use and less adoption of technology. Technology is changing the landscape of the banking sector, increasing access to banking services in profound ways. These changes have been in motion for several years, affecting nearly all countries in the world. During the COVID-19 pandemic, technology has created new opportunities for digital financial services to accelerate and enhance financial inclusion, amid social distancing and containment measures. At the same time, the risks emerging prior to COVID-19, as digital financial services developed, are becoming even more relevant. Broadening the financial access of low-income households and small businesses could also support a more inclusive recovery. These potentials, however, cannot be taken for granted, as the pandemic could accelerate pre-existing risks of financial exclusion, and give rise to new risks to the fintech sector itself.
Thirdly, banks need to adapt to a new customer norm with new business models in the post COVID-19 to make the sector more resilient. In the post COVID-19 period, Ghanaian banks will need to respond to lasting social changes, including how consumers select channel preferences, products, and banks for their individual financial needs, that are likely to result from the current crisis. Behavioural changes may accelerate the shift of the branch concept away from transactions toward a more complex, high-value operation. Decisions across distribution and product relevance will likely be key to this transition. Until now, most banks have marketed products using broad demographic segmentation. But customers are increasingly expecting individualized offerings, and leaders will need to use data to fine-tune their customer, product and pricing strategy to deliver on those expectations. Banks should continually strive to innovate in response to competition, changing customer expectations, technological innovations, and the drive for efficiency.
Next, financial inclusion through Fintech in the Post COVID-19 will make the sector more resilient and sustainable. The COVID-19 health crisis has created new opportunities for digital financial services to accelerate financial inclusion amid social distancing. According to the Alliance of Financial Inclusion (AFI), financial inclusion refers to all initiatives that make formal financial services available, accessible and affordable to all segments of the population. Particular attention should be directed to the segment of population that have been historically excluded from the formal financial sector due to their peculiar characteristics, regarding their income level and volatility, gender, location, type of activity and level of financial literacy. In general, the concept of financial inclusion goes beyond improved access to credit to include improved access to savings and risk mitigation products, a well-functioning financial infrastructure that allows individuals and companies to engage more actively in the economy, while protecting consumer’s rights. The health crisis led to the ‘lockdown’ as Ghanaian authorities opted for restrictive containment measures— lockdowns, quarantines, travel restrictions, and other social distancing measures— to bring the contagion of the virus under control. Fintech, including mobile money, helped people and firms to maintain and increase access to financial services during lockdowns and the reopening of businesses, given growing preference for cashless and contactless transactions to mitigate the spread.
Subsequently, Ghanaian banking institutions will need to enhance their approaches to risk management significantly, especially for credit portfolios. This can be done through the identification of existing and new risks, the assessment of the nature of these risks, and the validation of the existing risk management framework. Institutions may need to re-calibrate the indicators and triggers of all these risks in line with their shocks and impact on their portfolios. They might also need to refine the approaches to institutional risk management and mitigation measures. Banking institutions can develop and disseminate content to better prepare their staff to work in the new, post-COVID business environment. These modules can comprise lessons in the form of interactive sessions that include experience sharing. Further, institutions may also enhance their credit risk, liquidity, operational, capital management, recovery and resolution planning strategies.
Successively, Ghanaian banks need to formulate and implement radically altered strategies, new product lines and new revenue streams to build long term resilience. In the next phase of post-COVID recovery, banking institutions will need to transform radically to build resilience based on their level of preparedness, the macro-economic conditions they operate in and the context. As part of these revival and resilience-building efforts, institutions may develop a new product mix, such as new credit lines and innovative savings schemes geared to insulate clients against future disasters. Furthermore, they may build partnerships to offer products like wholesale lending credit lines to revive businesses.
Finally, Ghanaian banks would have to enhance their resilience to future risks by substantially building up capital and liquidity buffers. The increased use of stress testing by individual banks during the crisis also provides for greater resilience on a forward-looking basis, which should help support credit flows in good and bad times. In addition, developing economy such as Ghana, banks will have to shift to more stable funding sources and invest in safer and less complex assets. Some of these adjustments may be driven partly by cyclical factors, such as accommodative monetary policy, and hence may diminish as conditions change. There should be qualitative evidence to indicate that banks considerably strengthened their risk management and internal control practices. Although these changes are hard to assess, banks point to significant scope for further improvements, in particular, because of the inherent uncertainties about the future evolution of risks.