COVID-19: The Macroeconomic variables on the profitability of Banks.

Autore: prof. MICENE Vito Carlo
Le opinioni espresse non impegnano la responsabilità della società di appartenenza

Riproduzione vietata/Partial or total reproduction and trasmission is forbidden

The coronavirus pandemic could be the most extreme economic shock, post Lehman Brothers’ crack, that requires an ambitious macroeconomic reaction on all fronts to support people and firms at risk.

Monetary policy has to keep the financial sector liquid and ensure supportive financing conditions for all sectors in the economy because an economic contraction and a slowdown in activity will probably result in a deterioration in the quality of the assets of the European banks.

Financial shocks hit the banking system and the ECB reacted by implementing unconventional measures providing for:

  • Flexibility to operate below the level of capital defined by Pillar II (P2R and P2G), possibility to operate below the retention buffer of the capital (CCB) and of that relating to liquidity coverage ratio (LCR).
  • Favorable orientation towards loosening of the countercyclical capital buffer (CCyB) by the party of the national authorities.
  • Flexibility in the partial use of tools capital that does not qualify as Common Equity Tier 1 to meet the requirements of Pillar II e fill the capital needs.
  • ECB supports EBA’s decision to postpone the stress tests expected in 2020.
  • Benefit from a high degree of flexibility regarding the treatment of Non Performing Loans (NPLs) both in terms of classification to UTP and in terms of provisioning in the income statement.
  • new incentives for European banks to lend to SMEs as part of the review of the conditions set out in the TLTRO III program.

These represent shocks that could affected bank’s capital positions and also several operational aspects including bank merger operations, business prospects, credit quality, liquidity and profitability.
Macroeconomic variables included in the measures set by ECB mainly concern the real GDP, inflation, the rate of unemployment, the short- and long-term rates. All these variables influence banking profitability (the bank stock market index) and specifically net interest income, non-interest income, operational expenses loan loss and other provisions, households’ and firms’ default rates.
Profitability will be put under pressure by lower volumes and the increase in the cost of credit, while the current conditions of the financial markets will push institutions to at least partially suspend their funding programs.
Italian banks, could benefit all these measures, only if the probability that the slowdown in the economy in Italy will remain only temporary but projecting the crisis over a wide time span, the Italian banks are as among those that could suffer the most from the direct and indirect effects of the coronavirus pandemic.
This is the reason that prompted the Italian government and banks to introduce a moratorium on loans to temporarily provide relief to micro-enterprises and SMEs – they don’t have to be automatically classified as forbearance measures, for the purposes IFRS 9, as well as among NPLs, for the prudential classification of positions – or also, based on the analysis of the reference indicators, Bank of Italy, has decided to maintain the countercyclical capital buffer ratio (CCyB – it’s part of a set of macroprudential instruments, designed to help counter pro-cyclicality in the financial system) of zero per cent for the second quarter of 2020 because, already in the fourth quarter of 2019, the deviation from the long-term trend of the relationship between bank credit and GDP (credit-to-GDP gap) was largely negative.
Capital should be accumulated when cyclical systemic risk is judged to be increasing, creating buffers that increase the resilience of the banking sector during periods of stress when losses materialise.
This will help maintain the supply of credit and dampen the downswing of the financial cycle.
On the basis of the above, in order to maximize the support to the real economy, the SSM through the ECB, for the significant banks, and through Bank of Italy, for the less significant banks, considers appropriate that discretionary dividend distributions should not be made.
The ECB recommends that at least until 1st October 2020 no dividends are paid out and no irrevocable commitment to pay out dividends is undertaken by the credit institutions for the financial year 2019 and 2020 and that credit institutions refrain from share buy-backs aimed at remunerating shareholders.
The reasons why understanding how credit banking quality will evolve, in response to macroeconomic conditions, is of utmost importance to assess the resilience of the banking system.
Banks set their “optimal economic capital ratios” in reaction to changes in macroeconomic conditions mostly by modifying their RWAs and is known the historical relations between the macroeconomic variables and the Tier1 ratio that it allows, along with other variables, the transmission of monetary policy.
These relation was interrupted only during bank capital shocks occurred in 2008.
As the crisis in 2008 also the COVID-19 crisis may have induced quick changes in the relations between the business cycle, the financial market and the banking variables.
In the course of 2020, the banking industry will be called to an important undertaking because, in the face of a reducing profitability, need to guard the quality of assets in view of NPEs Ratio’s multiannual objectives and preserve quantity and quality capital endowment.
Whether the significant tightening of the rules on non-performing loans promoted by ECB from 2014 and carried out with the publication of management guidance by the ECB of the NPE in 2017, with the addendum of 2018 and the recent Calendar provisioning brought a marked improvement in the quality of bank assets, the “lockdown” phase imposed by Governments may jeopardize both the possibility of obtaining recoveries through the strategy judicial (is the case of Italy which closed all the Courts) both the ability of debtors to honor out-of-court agreements due to growing economic difficulties.
Over the last few years, Italian banks have completed important divestment of impaired receivables, significantly contributing to the reduction of the NPL Ratio both at the level of the individual intermediary and at the national level. Examples are the divestments of UTP credits or the birth of a prosperous secondary market for suffering.
Deleveraging and derisking strategies must necessarily consider the changed macroeconomic environment, and the impact on profitability banks and on their financial statement; this could result into a reduction of performance indicators as cumulative Collection Ratio (CCR) and Profitability Ratio (NPV ratio).
In a forward-looking sense, there is an increase in Credit Default Swap (CDS) and in the future, investors and rating agencies could use more conservative approaches based on more prudent assumptions in the estimation of gross recoveries and related timing. This could therefore have negative effects on the selling and signing prices of the notes with impacts on the seller banks’ Income Statements (P&L).
However, contingent adverse effects may be mitigated or even cancelled by government support measures and by possible tax benefits (DTA) as provided by the Italian Government in accordance with Article 55 of the Decree “Cura Italia”.

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