Managing credit risks diligently

Banks have a stronger liquidity buffer than in 2008.  However, Mauritius' inclusion in the EU’s provisional list of High-Risk Third Countries is likely to affect cross-border flows, highlights AfrAsia’s Head of Risk

To what extent banks have a key role to play in supporting the real economy to survive the crisis caused by the Covid-19 pandemic?

Yes, during this pandemic, banks are having a more prominent role to play in sustaining the economy until recovery time, alongside a level of state intervention the world hasn’t even seen in wartime. Governments are using banks as a transmission mechanism to implement their support and relief measures. Banks should be able to sustain their clients for a period of time with the implementation of a number of measures including lines of credit from the central bank, regulatory forbearance measures, easing of macro prudential guidelines and participation in credit risk by the government. These measures ensure that loans are not classified as impaired assets immediately and banks are able to support their clients and the economy at large.

Does the significant strengthening of prudential regulation over the past decade since the 2008 financial crisis has enabled banking institutions to post solid levels of capital and liquidity?

Indeed, it has. During the 2008 financial crisis, the banking industry experienced management, regulation and measurement failures. Since then, under the Basel III regulations, banks have been required to maintain a capital conservation buffer in order to safeguard banks during financial and economic stress. We have in fact noted that banks worldwide have been able to secure 25% more capital, which could be used to absorb losses. Due to this, most banks entered the COVID-19 crisis with strong capital buffers.

In addition, Basel III has explicit liquidity requirements which forces banks to have High-quality liquid resources to survive an acute stress scenario lasting for one month. Banks are also expected to have longer-term stable funding relative to liquidity profiles of assets funded and the potential calls on funding liquidity arising from off-balance sheet commitments. Hence, banks have a more robust liquidity cushion than they did in 2008.

Many observers expect a shock to the financial sector similar in magnitude to the 2008 crisis to occur. Are there growing pressures on the banking system and can we expect a higher default on debt?

This current crisis is different from the 2008 one as it is a sanitary crisis that became a multidimensional crisis affecting the economy and financial markets. While banks are better prepared to tackle this crisis due to the new regulations, they will face higher credit risks and higher default rates. However, with the Government Support Programmes and regulatory forbearance measures, banks will be able to support the impacted sectors and sustain their lending activities for the time being.

Consequently, banks will need to diligently manage their own credit risk and assess permanent damages to certain borrowers. From an overall banking perspective, risks should be properly diversified across different assets classes bearing in mind the tenor, ticket size, products, assets quality, country of risk, available capital, historical loss experience and other attributes as per banks’ risk appetite and ability to absorb losses.