Financial Institutions Exposed to Long-Lasting Economic Scars – Fitch
Fitch Ratings has hinted that financial institutions are exposed to long-lasting economic scars following the outbreak of COVID-19.
Specifically, it stated in a report that banks’ operating environments will probably remain challenging long after the pandemic.
“We expect increased unemployment and economic weakness to pressure asset quality, particularly for lenders with high exposure to SMEs”, the Ratings firm added.
Explaining, the firm thinks that weak credit demand and reduced capital market activity will suppress earnings.
It said conditions are likely to be credit-negative for all but the largest global and domestic systemically important banks, and could catalyse industry consolidation.
According to Fitch, the rating impact on banks will vary according to their region and the extent of government measures aimed at supporting borrowers.
Fiscal support measures during the current crisis have helped banks’ financial metrics by limiting, or at least deferring, credit losses, Fitch said.
Similar support might be forthcoming in future crises, which would again help banks, albeit at the expense of sovereign creditworthiness.
Fitch stated that economic scars could lead to more sovereign downgrades in the aftermath of the pandemic.
This would put pressure on bank ratings that reflect potential sovereign support – a common feature in emerging markets.
Banks whose ratings are clustered around the sovereign rating of their domicile could also be affected if that sovereign rating is downgraded, it added.
It explained that the role of development and policy banks, including supranational organisations, will become even more entrenched in many economies.
“Not only will there be less private investment, but these entities will increase their funding of public infrastructure, potentially leading to a loss of market share for commercial banks”, the ratings firm stated.
The Ratings firm further stated that non-banking financial institutions (NBFIs) also face adverse operating conditions.
However, Fitch said they are less constrained by regulation than banks are.
It said NBFIs may be able to grow in the riskier, but potentially more profitable, segments that banks are likely to avoid in anticipation of asset quality deterioration.
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NBFIs have good growth opportunities in many emerging markets despite the economic effects of the pandemic, due to still-low credit penetration and limited banking presence, the Ratings added.
It stated that the US health insurers could be particularly affected by the pandemic’s longer-term ramifications.
The health crisis may have set a precedent for increased government involvement in the health insurance market, and made regulatory intervention that favours customers over insurers more likely.
In the US, business interruption insurance may be redefined in the wake of the pandemic so that businesses can have more clarity on what they are covered against.
Several insurers rejected pandemic-related business interruption claims on the grounds of policy wording, arguing that coverage did not apply in the context of a pandemic.
However, a test case in the UK led to a court ruling that largely went against insurers.
Fitch however said given the scale of pandemics and the difficulty of precisely defining related losses due to business interruption, it may be that government-funded solutions will be developed in readiness for future pandemics, perhaps similar to those that apply in some jurisdictions for natural catastrophe losses.
For bond funds, Fitch said economic scars may lead to the credit quality of underlying bond holdings deteriorating, to the detriment of investment performance.
It added that this could result in fund outflows.
However, the Rating explained that unless a fund is significantly overweight in a given holding relative to its peer funds, outflows are unlikely to be large enough to affect its rating.
