Banking systems remain robust and in good shape to withstand incoming bad debt increases: Moody's

September 24, 2020: Most banking systems remain robust and in good shape to withstand incoming bad debt increases. Capital strength will be crucial for banks to support creditworthiness in the medium-term but existing profitability challenges will be compounded.

The global banking system is well placed to absorb the economic shocks triggered by the coronavirus, but a second wave of the virus, leading to new blanket lockdowns or self-imposed changes in consumers' behavior, poses a significant threat, Moody's Investors Service said in a report today.

The outlook for global banks turned overwhelmingly negative in early 2020 as the pandemic struck and restrictions on economic activity began to bite. Over three-quarters of 70 Moody's Banking System Outlooks are now negative, which contrasts with the 14% that were negative at the end of 2019.

However, after ten years of broadly benign economic conditions, and relentless regulatory pressure to reinforce balance sheets, most banking systems are in good shape and can withstand the inevitable rise in bad debts over the coming months. In addition, actions taken by central banks and governments to soften the virus impact have slowed the rise in asset risk and underpinned liquidity and funding.

"In contrast to the financial crisis, the banking system is more likely to act as a shock absorber rather than an amplifier," says Nick Hill, Managing Director – Banking at Moody's Investors Service. "But a second wave of the pandemic that leads to new lockdowns and economic turmoil could cause more lasting damage to banks' credit profiles."

In a context of profound uncertainties, the ability to preserve and restore capital in the medium term will be a crucial support to banks' creditworthiness. European banks are at an advantage because their starting capitalization is higher than banks in most other regions.

Banks with more diversified business models – notably those with capital markets activities – will also prove more robust than those focused on more susceptible activities like lending to small businesses and corporates. Challenges will be greatest in areas where profitability was already weak such as Japan and Europe, and where necessary restructuring is consuming pre-provision profits and reducing loss absorption. Similarly, rapid digitalization and low-interest rates will further compound the risks facing banks with lower efficiency.