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Thursday December 1st, 2022

Banking and COVID-19: engineering a recovery

ACCA Member Nandika Buddhipala, CFO at listed Commercial Bank of Ceylon Plc

The Pandemiconomic Impact: Insights from ACCA finance professionals

ACCA Member Nandika Buddhipala, CFO at Sri Lanka’s largest private bank, listed Commercial Bank of Ceylon Plc, discusses the expectations of an entire nation harmed by the global coronavirus pandemic that the banking sector will drag the economy out of the doldrums.

Overwhelming expectations

There is an expectation that banks will support the economy to survive and recover from this unprecedented pandemic and economic slump. I do not believe the expectations are unrealistic.

The government, Treasury, the Central Bank, businesses, and individual citizens have all turned their eyes towards the banking sector for deliverance.

Sri Lanka does not have a vibrant stock market or venture capital industry to meet the economy’s capital needs. Market capitalisation at the Colombo Stock Exchange was around 20% of the GDP before the pandemic, in India, it’s around 80%. Development banking is also not large enough either. For these reasons, there’s increased expectations for the banking sector to play a major role in the financial intermediary space.

It is not surprising then that as a financial intermediary in the economy, the banking sector is also significantly affected by the pandemic.

If you consider the total portfolio of the entire banking sector, about 20-23% comprise of personal loans, 20% construction, 8% trading and another 8% covers loans to the agriculture and fisheries sectors. The banking sector’s exposure to other financial institutions is about 6% and 4% each to apparels and tourism.

With most businesses struggling to survive the economic effects of COVID-19 and as employees take salary cuts, the impact on banks becomes clear. For instance, it may appear that the banking sector exposure to the apparel and tourism sectors, the most affected by the pandemic, is only 8% but they extend to the wider economy and various other industries across several banking products so the exposure is significantly large.

The apparel sector alone provides direct and indirect employment close to a million people and tourism provides between 350,000-400,000 jobs. Because of pay cuts or leave without pay, if most of them cannot service their personal loans, mortgages or credit cards, the impact on banks will be huge.

Now consider banking exposure to many other sectors that are seeing little to no activity, like construction for instance, and the scale of the banking sector’s challenge becomes evident.

Driving the economy

The government unveiled a debt moratorium scheme, an Rs50 billion concessionary loan package and the central bank has reduced benchmark policy rates to bolster the economy. Governments world over are handing out stimulus packages to keep economies alive rather than precipitating a downturn.

As a result, you could expect to witness the significant deterioration of banking margins and earnings. There will be a significant deterioration of credit risk and this is true for banks anywhere in the world; after all, this is an unprecedented global pandemic. However, it was widely felt that the current pandemic would be a short-term phenomenon. What we need to be conscious and cautious about is the continuous assessment of the longevity of the pandemic, and the ability of the banking sector to absorb the expectations of all stakeholders without exposing the banking sector to severe negative impacts.

Sri Lanka locked down the economy and successfully prevented the pandemic from spreading. Two months later, the economy is trying to regain some normalcy while some advanced economies are still battling to contain the coronavirus. The opening of the economy has contributed to containing the deterioration of credit quality.

While it will take time to find a vaccine, and despite widespread uncertainty word over about the global economy, the expectation is that this pandemic is not going to be as much long-lasting compared to prolonged recessions in the past. However, the earlier universal confidence that COVID-19 was a temporary phenomenon is now challenged. Economic recovery will be slow and must factor into any corporate strategy.

The banking regulator has directed banks to strengthen capital buffers for some time. Capital adequacy levels increased to 10% for Tier-I systemically important banks. Because of the economic crisis now, the regulator has allowed these banks to release 50-100 basis points from the capital adequacy buffer. Some of these banks maintained capital adequacy levels well above the statutory level so the easing of the regulatory buffer results in a significant lifeline. This could release significant space for banks to increase lending capacity to the economy.

Before the pandemic, banks had also received generous tax cuts. This was to revive an economy already in distress since the 2019 Easter terror attacks. Effective tax rates which had been 55% for most banks are now about 45%. So, there was some breathing space, to begin with.

Worthwhile investment

Small and medium businesses generate more than half the country’s jobs. They account for nearly half of Sri Lanka’s Gross Domestic Product. Yet they have few alternatives to raising capital. Their dependency on the banking sector is now acutely felt.

This led to the conceptualisation of the debt moratorium and concessionary lending scheme in the first place. Earlier, targeted businesses included manufacturing, agriculture and processing, construction, value-added exports, and trading companies with a turnover below Rs1 billion. The banking sector took this seriously because these businesses must survive. After all, the entire economy depends on it.

Next, we looked at the sectors harmed by domestic work disruptions and overseas lockdowns. These included companies in tourism, exports, apparels, tech, plantations including tea and spices, and logistics. They need bigger loans. Some of them are large companies that generate considerable foreign exchange and investments.

Borrowers can avail themselves of the moratorium for a range of lending instruments like term loans, pawning, leasing, overdrafts, and trade finance.

Sri Lankan bankers are conscious of the need to extend facilities beyond the scope of the moratorium scheme. Banks will have to take calculated risks to kick start the economy so that business can survive and keep people employed.

Once we achieve an economic revival, then borrowers will be able to service their loans. This will benefit the banks, their shareholders, depositors, and employees. Everybody gains when the economy grows. Driving economic growth is the purpose of banks.