The global economy is emerging from one of its deepest slumps and beginning a passive recovery after the distressing health and economic crisis caused by COVID-19. Policymakers are facing tough challenges in debt management, budget policies and central banking as they are trying to ensure that this still-fragile global recovery pickups momentum sets a substance for vigorous evolution and development in the coming time. Growth in global Emerging Market and Developing Economics (EMDEs) output is expected to expand 4% in 2021, however, it is still remain more than 5% below of pre-pandemic projection. Global growth is projected to moderate to 3.8 percent in 2022, weighed down by the pandemic’s lasting damage to potential growth.
Right now the challenges related to limiting the spread of the virus and development and deployment & administration of vaccines are major priorities. Global community requires to act rapidly and forcefully to make sure the ongoing debt wave does not end with a string of debt crises in EMDEs. As the crisis subsides, policy makers need to balance the risks from large and growing debt loads with those from slowing the economy through premature fiscal tightening. To confront the adverse legacies of the pandemic, it will be critical to foster resilience by safeguarding health and education, prioritizing investments in digital technologies and green infrastructure, improving governance, and enhancing debt transparency.
Although global trade in goods has largely rebounded, trade in services remains feeble. Global financial conditions are being supported by monetary policy accommodation, but financial systems in many countries are showing signs of underlying strain. Whereas most commodity prices, particularly those of metals, rebounded in the second half of the year as demand firmed, the recovery in oil prices has been more modest.
Though all regions are expected to grow this year, the pace of the recovery varies considerably, with greater weakness in countries that have larger outbreaks or greater exposure to global spillovers through tourism and industrial commodity exports. The East Asia and Pacific region is envisioned to show notable strength in 2021 due to a solid rebound in China, whereas activity is projected to be weakest in the Middle East and North Africa and Sub-Saharan Africa regions. Many countries are expected to lose a decade or more of per capita income gains.
Aggressive policy actions by central banks kept the global financial system from falling into crisis last year. Financial conditions are generally loose, as suggested by low borrowing costs, abundant credit issuance, and a recovery in equity market valuations amid positive news about vaccine developments. This masks rising underlying vulnerabilities, however, including rising debt levels and weakening bank balance sheets. Debt burdens have increased as corporates have faced a period of sharply reduced sales and sovereigns have financed large stimulus packages. This follows a decade in which global debt had already risen to a record high of 230% of GDP by 2019. High debt levels leave borrowers vulnerable to a sudden change in investor risk appetite. This is especially true for riskier borrowers and EMDEs dependent on capital inflows to finance large fiscal and external current account deficits. Capital in-flows to many EMDEs remain soft, with significant weakness in both foreign direct investment (FDI) and portfolio flows. This, alongside a collapse of export revenues, has led to substantial currency depreciations and rising borrowing costs in some countries, particularly commodity exporters.
Banks’ capital buffers are under pressure due to falling profitability and asset quality deterioration. Defaults have already surged in the hardest-hit sectors and countries, and rising credit downgrades point to further strains in the future. These developments reduce the resilience of financial systems, particularly in countries with weaker banking systems or without the policy space to provide sufficient support to stressed financial institutions.
While banking seems to be changing, so does the purpose of banks. Societies around the world now expect banks to help address income inequality, racial and gender inequity, and climate change. As vital engines of growth in the global economy through a multitude of roles—financial market intermediaries, asset owners, investors, and employers—banks have a critical role to play in sustainable finance. In addition to helping allocate or redirect capital toward economic activities that are net positive to societies, they can also nudge new behaviors among clients and counterparties.
Banks can play a leadership role in driving the sustainable finance agenda but will need to engage with other institutions to solve the many problems in this area. More importantly, banks played a crucial part in stabilizing the economy and transmitting government stimulus and relief programs in the United States, Canada, the United Kingdom, Japan, and many European countries, among others. Banks’ healthy capital levels before the pandemic also helped mitigate the negative impacts from the crisis and should pave the way for the global economy to thrive in the future.
For the banking industry, the economic consequences of the pandemic are not on the same scale as those during the Global Financial Crisis of 2008–10, but they are still notable. In addition to the financial fallout, COVID-19 is reshaping the global banking industry on a number of dimensions, ushering in a new competitive landscape, stifling growth in some traditional product areas, prompting a new wave of innovation, recasting the role of branches, and of course, accelerating digitization in almost every sphere of banking and capital markets.
Some of these forces were already in motion before COVID-19. Global GDP growth was waning, but the pandemic exacerbated the slowdown. The International Monetary Fund (IMF) expects global GDP to decline by 4.4%, or almost US$6.2 trillion in 2020. Despite a possible rebound in 2021, global GDP could still be US$9.3 trillion lower than what was expected a year ago. This drastic contraction in the global economy has already meaningfully diminished loan growth and payment transaction volumes. These declines have been largely offset by near-record levels of trading revenues and wealth management fees. But as the pandemic continues, banks will likely be confronted with a greater share of distressed assets on their books. The Deloitte Center for Financial Services estimates that the US banking industry may have to provision for a total of US$318 billion in net loan losses from 2020 to 2022, representing 3.2% of loans. While losses can be expected in every loan category, they may be most acute within credit cards, commercial real estate, and small business loans. Generally, these losses are smaller than during the GFC, when US banks recorded a loss ratio of 6.6% from 2008 to 2010.
As of second quarter 020, the top 100 US banks had provisioned US$103.4 billion, in contrast to US$62.5 billion for the top 100 European banks and US$68.8 billion for the top 100 banks in Asia-Pacific. Deloitte’s proprietary forecasts for the baseline economic scenario indicate that the average return on equity in the US banking industry could decline to 5.6% in 2020 but then recover to 11.7% in 2022. Similarly, sell-side broker estimates suggest that the average ROE of the top 100 banks in North America, Europe, and APAC could decline by almost 3 percentage points, to 6.8% in 2020. Banks in North America and Europe aren’t expected to recover to 2019 levels anytime soon, with APAC banks potentially only getting near their pre-COVID-19 ROE average level of 9.2% by 2022. Low rates are expected to keep net interest margins suppressed, creating strong headwinds to banks’ interest income growth.
The International Monetary Fund (IMF) now projects the global economy to expand 5.5% this year and 4.2% next year due to additional policy support in a few large economies and expectations of a vaccine-powered strengthening of activity later in the year, which outweigh the drag on near-term momentum due to rising infections. It is projected that the US economy will grow 5.1%, the euro area 4.2%, and China 8.1% this year i.e. 2021. If equitable access to inoculations isn’t prioritized, vaccine nationalism in advanced economies could cost the global economy $9.2 trillion in lost output this year alone. In advanced economies, roughly 7% of Americans, 11% of Britons, and 2% of EU citizens have been vaccinated as of this week, according to figures tracked by Our World in Data. Emerging economies such as India and Mexico have vaccinated just 0.1% and 0.5%, respectively, of their populations.
The pandemic has had a devastating impact on South Asia, leading to an estimated 6.7 % output contraction in 2020. The region is projected to grow by 3.3% in 2021 and 3.8 % in 2022, substantially weaker growth than during the decade leading up to the pandemic. COVID-19 is expected to inflict long-term damage on growth prospects by depressing investment, eroding human capital, undermining productivity, and depleting policy buffers. The outlook is highly uncertain and subject to multiple downside risks, including the possibility of more severe and longer-lasting damage from the pandemic, financial and debt distress related to an abrupt tightening of financing conditions or widespread corporate bankruptcies, adverse effects of extreme weather and climate change, weaker-than-expected recoveries in key partner economies, and a worsening of policy- and security-related uncertainty. Financial sector fragility in many economies requires active intervention by policy makers to mitigate the risk of crisis.
In Pakistan, the recovery is expected to be subdued, averaging 1.3% over the next two fiscal years; which is slightly better than expected in June 2020 but below potential growth. Growth is projected to be held back by continued fiscal consolidation pressures and services sector weakness. It is predicated that on maintaining reform momentum and adherence to a macroeconomic-sustainably framework. Limited prospects for a strong rebound in the services sector will aggravate poverty. This sector represents about half of Pakistan’s output and are an important source of income for low-income households. Despite challenging macroeconomic environment, banking sector maintained its growth trajectory during the first half of 2019 largely, backed by decent growth in deposits. Besides seasonal factors, rise in minimum saving rate and inflows related to amnesty scheme increased the flow of deposits. Due to slowdown in flow of advances and tilt of the government borrowing to central bank, most of the growth in assets reflected in increase of end period ‘cash and balances’.
Among the advances, flow of private sector advances observed a broad-based slowdown owing to subdued economic activity and continued monetary tightening, while flow of public sector advances declined due to lower utilization of commodity financing and retirement of energy sector advances. Asset quality saw some deterioration, with increased volume and share of non-performing loans, particularly in agriculture and energy sectors. While investments observed a marginal rise, banks renewed their interest in PIBs due to favorable interest rate dynamics.
The overall risk profile of the banking sector remained satisfactory. The earnings of the banking sector improved owing to increase in Net Interest Income (NII), which improved all the profitability indicators. The resilience of the banking sector remained robust as the Capital Adequacy Ratio at 16.1% was well above the local and international minimum benchmarks of 11.9 % and 10.5%, respectively. With the approaching deadline, banks need to ensure effective implementation of their plans for meeting the enhanced capital requirement of 12.5 % by end December, 2019.
According to SBP’s mid-year performance review, despite elevated economic stress driven by the COVID-19 pandemic, the assets of the banking sector witnessed a decent expansion of 7.8% percent during the first half of calendar year 2020. Due to a steady flow in deposits, a healthy increase in investments, elucidates this growth. On the other hand, the advances experientially went insignificant increase owing to the economic sloppiness which was instigated by the disruption in the business activities after the pandemic. Due to SBP’s corrective measures, the contraction in advances is much lower than expected. The policy measures trundled out by SBP eased the banking sector in conserving the capital, enhancing the lending capacity and increasing the loss absorption ability. Resultantly, banking sector demonstrated improved profitability and enhanced pliability, despite some increase in credit risk. The policy measures taken by SBP to alleviate the implications of COVID-19 have been very well received by the stakeholders. The Non-performing loans ratio increased from 8.6% in December 2019 to 9.7% by June 2020. The net NPLs to loans ratio slightly increased from 1.7% to 1.9%.
The earnings marked visible improvement as profitability jumped by 52% on year-to-year basis. This improvement resulted from higher interest income, deceleration in interest expenses and rise in non-interest income. With better profitability, the soundness of the banking sector further strengthened as Capital Adequacy Ratio increased to 18.7 % in June 2020 from 17.0% in December 2019.
The results of SBP’s Systemic Risk Survey (SRS) conducted in July-August, 2020 indicate that, at present and for the next six months, the respondents consider global risks and domestic macroeconomic risks to be important.
[box type=”note” align=”” class=”” width=””]The author, Nazir Ahmed Shaikh, is a freelance columnist. He is an academician by profession and writes articles on diversified topics. He could be reached at [email protected][/box]