Despite the stress, entities in the financial services industry can look for opportunities to grow through strong risk management, robust collection, effective cost control and increased use of technology.
By Charanjit Attra
The COVID-19 pandemic has impacted the social as well as professional lives of people. All are speaking about the ‘new normal’ and yet no one is clear on what this is going to be. Whatever the new normal is expected to be, the sectors which are getting affected the most and which will continue to be severely impacted would be sectors which touch people’s lives on a daily or regular basis. One such sector would be the financial services sector which primarily includes banking companies, non-banking financial services and insurance industry.
The Reserve Bank of India (RBI) has provided the banks liquidity in the form of reduced rates for lending generally or to specific sectors and the Indian government has agreed to offer credit guarantee to certain micro, small and medium sector enterprises (MSMEs) and other sectors. It has also asked banks to offera moratorium to borrowers to pay instalment and interest for three months. Further, for banks the RBI has also relaxed the provisioning norms.
The above steps taken by the RBI would definitely help the banks and their borrowers to tide over the immediate liquidity requirements and the need for cash as the occurrence of the pandemic and the impact of lockdown resulted in reduced or no income for the borrowers of the banks. These measures would help them to tide over the immediate issues.
However, Covid-19 could have some negative impacts on the banks in the future:
- The banks may run the risk of increased bad loans or non-performing assets (NPAs) if the borrowers who avail the moratorium are unable to generate cash or the cash generated is insufficient to honour the required payments of interest and instalments in a timely manner.
- There could be an aggregation or accumulation of provisions and losses in the period in which the exemptions are lifted.
- If the pandemic continues for a longer time than anticipated, there could withdrawals of deposits, which could result in the replacement of low cost deposits with high cost borrowings resulting in an adverse impact on net interest income, spreads and margins.
- Banks may not find proper avenues for lending due to the status of the economy resulting into either excess funds lying idle or being invested in low yielding investments
There would definitely be challenges faced by banks. However, if the banks have robust risk management functions and can partner with borrowers who show potential and can adapt to the new normal, there would be enough positives and benefits. The key would be to identify the right set of borrowers and partner with them to help them through this entire cycle
Non banking financial companies
NBFCs would face similar challenges like banks on the asset side. However, maintaining liquidity and capital would be a greater challenge for them. Some of the large NBFCs would need to create provisions as per Ind AS, which requires provisions to be computed based on the expected credit losses.
Accordingly, they would need to compute provisions based on losses expected in the future years . Normally, lenders use the past history of defaults and losses to compute the expected credit losses and adjust them for the future based on their trends with the macroeconomic factors.
Since the Covid 19 sort of impact is unprecedented, it will be very difficult for them to compute the expected credit losses. Many regulators in India and abroad have issued guidance asking the lenders to take a longer term view rather than a short term view while computing the provisions.
Further, some of the NBFCs give loans to small businesses (micro finance) for which repayments cannot be estimated in this situation as there would be higher losses. NBFCs which have robust collection systems, however, might perform better than their peers. Also the provisions would depend on the areas where the NBFCs have been lending . For example, NBFCs operating in relatively less affected areas would have lesser provisions and vice versa.
COVID-19 and the related lock down would impact the general insurance companies much more than the life insurance companies. Broader impact is expected as follows:
- There would be a fall in the premium income, particularly in motor loans, as the new car sales have stopped due to the lockdown . However, the claims are also expected to be lower
- If the pandemic goes on for longer, there would be higher mediclaims resulting into a higher costs
- There would be constraints on capital raising as liquidity of the parent (if they are banks or NBFCs) would be under stress
On the life insurance side, there could be higher claims and the actuarial assumptions could undergo changes due to changes in actual experiences.
On an overall basis, entities in the financial services industry would be under stress . However they should work cautiously and look for opportunities to grow. Strong risk management processes, robust collection policies, effective cost control measures , increased use of technology would help entities in the financial services to pass through these testing times.
Till the time there is no solution for the coronavirus in terms of a vaccine or an antidote, we will have to live with the issue, practice social distancing and carry on business to achieve the desired results.(The author is a partner of Ernst and Young Associates LLP, a member firm of the accounting and audit network, EY. Over the last few years, he has been advising companies in the financial services space on the transition to the new accounting standards, the Ind-AS. In his earlier corporate avatar, he was CFO at 3i Infotech and ICICI Securities)
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