How banks can strategically respond to Covid-19 challenges

17 April 2020 11 min. read

As most other organisations, banks are currently facing an environment of extremely high uncertainty. Experts from consulting firm Corporate Value Associates outline how banks are being impacted by Covid-19 and how they can strategically respond to the global pandemic. 

Covid-19 is adversely impacting the banking sector in four significant ways: 

Impairment of portfolio quality
Banks will need to be extremely proactive to prevent both a surge in credit defaults, and the subsequent collapse in the value of loan collateral that a wave of distressed sales of property assets might trigger. Offers of repayment holidays combined with effective channelling of state support to businesses in need are the two primary tools available, and banks are already acting at pace in this regard.

In the background, banks will need to copy health systems by engaging in triage to prioritise their support efforts, based on assessments of which sectors are most likely to recover or be recoverable, to save as many customers as they can, while ‘spreading the peak’ of those they cannot. 

Shrinking value in the balance sheet
Interest rates may remain near zero or in negative territory for some time. This makes retail deposits (with higher OPEX than wholesale operations) relatively expensive, and passive assets funded by them will exhibit an increasingly negative profit contribution. In turn, this will create an incentive to restructure the balance sheet by actively driving retail deposit outflow. 

The challenge is that, after a decade of rock bottom deposit rates, consumer price sensitivity to further rate reductions is extremely low, and as we move into what could be another protracted global recession with rapidly rising unemployment rates, the majority of mass market customers will prioritise capital security over higher risk / reward investments. 

A further issue is that, should they succeed – for example if large numbers of customers end up drawing down their savings to pay bills – banks will increasingly start to look like non-bank lenders but with substantially higher regulatory costs, squeezing margins further. On the demand side, in a prolonged recession, new lending volumes are likely to fall substantially in any case. 

Flow of liquidity elsewhere
As central banks attempt to shore up the economy, the amount of money in circulation is rising. Except where banks are required to act as conduits for state support to businesses, bank balance sheets are at a structural competitive disadvantage (see point above) when it comes to capturing these additional funds, and much of this new liquidity will flow elsewhere.

Banks have an opportunity to capture value from it in different ways, e.g. by providing value-adding services such as credit underwriting to the alternative players / balance sheets where these funds end up, but need to radically evolve in order to do so.

Increased societal scrutiny
The sector has still not recovered in image terms from the financial crisis of 2008/9. It will not be enough for banks to work flat out to support their customers in their time of need; they will need to be unequivocally seen to be doing so in an environment where politicians may be looking for scapegoats if large numbers of businesses collapse and unemployment rises steeply.

Business progression along the Covid-19 timeline, with major uncertainties

The future will be different – but how, exactly?

We can reasonably expect all businesses (including both banks and their customers) to progress through four phases of Covid-19 response, with different needs and imperatives at each stage (see above) subject to major uncertainties in timeline and scale of market impact.

However, predicting the specifics of the ‘new normal’ at this stage is simply impossible.

For instance, we can see that with the high street closed down, and the general population other than designated key workers largely under a form of voluntary house arrest, consumer and business behaviour has already changed. Some of these changes – a shift to online shopping and home delivery; an uptick in consumer use of video conferencing to maintain social circles; a surge in at-home alcohol consumption; people rapidly becoming extremely wary of crowds – were entirely predictable. 

Others are quite unexpected – entire neighbourhoods of people setting up WhatsApp chat groups to share information and offers of shopping for those in self-isolation; a rediscovery by large swathes of the population of the desire to undertake exercise; a sudden and widespread craving for dried pasta in any form. 

The unanswerable question is which of these changes will persist once normality returns, i.e. will new habits have formed. If businesses realise they can in fact manage just fine without holding face to face meetings, airlines and the hotel industry may never fully recover. If the population remains wary of crowds for the foreseeable future, fearing further infection waves, large scale entertainment venues may experience a long-term reduction in footfall. Whether consumers now used to ordering most of what they need online will return in droves to physical retailers once stores reopen remains to be seen. 

Equally, once government supply-side support is removed, advanced economies stand on the precipice of a potential collapse in employment the severity of which is unknown.

Strategic planning in an uncertain world

One option when faced with major uncertainty is to do nothing and wait until the picture clears – which is of course a choice in its own right, and at the moment potentially a disastrous one. Now, more than ever, CEOs need to lead the way in safely navigating through treacherous waters. 

However, the traditional decision-support tools – data analysis, forecasting, and scenario planning – are of limited use when the situation is changing on a weekly basis, and new information is continually coming to light. With so many major uncertainties at play, it is simply not possible to predict the future with any degree of confidence at the moment, even over relatively short timescales. A strategy based on a single, hard-coded view of the next 12-24 months will be quickly overtaken by events. 

Instead, at Corporate Value Associates, we advocate an approach based on two simple ideas.

First, instead of trying to definitively predict the future, work backwards (‘retropolate’) from a broad range of plausible scenarios to identify no-regret moves that make sense regardless of how the future turns out, as well as option moves that can be implemented as and when it becomes clear that the world is moving in a particular direction.

Second, develop an agile strategic plan that delivers in small increments, over short timescales, allowing pivots where necessary, rather than committing to a long, inflexible delivery programme whose direction cannot easily be altered. Invest in putting a set of leading indicators in place, monitored continuously, so the strategy can be adjusted as market conditions alter. 

An imperative for change

The Covid-19 crisis creates an enormous imperative for transformational change and the window to act is relatively narrow. Regardless of exactly how the ‘new normal’ turns out, we see a number of key (and interlinked) no-regrets moves: 

Agile and digital
Banks rapidly need to become more agile, more digitally savvy, and must be able to delight their customers in the way they serve them. Covid-19 shows that even in a highly digital world, people look for human interaction and support, and real trust – something that is critical in all customer segments, both personal and business – can still only be established this way. 

This means banks need to develop substantially better capability in digital channels that retain the human touch, such as video calling, and live chat. Financial institutions that can best establish this human component, with individuals and with communities, will win large customer bases and a relationship of trust that they can subsequently leverage to develop new revenue lines. 

New revenues streams
Expand the service footprint to generate new fee income in adjacent areas. While banks have attempted this in the past with varying degrees of success, the new realities of the post-Covid world will create a new opening.

Financial services platforms that have struggled to achieve more than niche adoption, such as remote authentication and signing services, online trading platforms, and online credit platforms, now find themselves on the brink of being major players as customers suddenly find they must do business in different ways. It is notable that many of these platforms do a far better job at bridging the digital-human link than traditional banks.

Transform the risk function
The Risk function can no longer simply operate on a transactional basis assessing individual counterparties and projects. The Risk function of the future must assume a much more proactive role and be systematically involved in all business decision processes, as well as helping communicate with clients so they understand how banks operate.

Ranking of major international banks according to their cost-income ration X revenues

Do not automate, obliterate
In our experience, a customer-centric programme of radical transformation aimed at vastly improving the customer experience in a digital world, and re-aligning processes to customer value creation, will often also have the benefit of delivering very substantial efficiency savings, because such a programme does not simply involve further automation of existing processes, but rather the ‘obliteration’ of existing processes and their replacement with fundamentally customer centric ones.

Such an approach can, once there is more breathing room, be extended quite widely across the bank. This will be critical in the longer term – many banks have gone into the current crisis with cost / income ratios that may become unsustainably high given the expected long-term reduction in balance sheet revenue they face.

Pursue disruptive scaling
Furthermore, we strongly believe that never again will it be this cheap to scale disruptively. Crisis mitigation (‘first response’) and disruptive transformation are not mutually exclusive sets of activities. They can and should be addressed through one single set of integrated actions that blend short-term imperatives with long-term strategic aims. In the current environment, the imperatives of the short term have relaxed, or in many cases removed, the barriers to disruptive transformation in the industry, creating a sweet spot for CEO focus at the confluence of short-term need and long-term end game.

To this end, we propose two highly disruptive option moves to explore:

  • The balance sheet-less bank – moving from banking as a balance sheet activity earning interest income, to banking as a service earning fees, with an outsourced balance sheet.
  • Ecosystem scaling beyond banking – moving into non-banking consumption verticals either directly or in partnership where banks can achieve legitimacy with customers. 

About the authors: Simon Vessey (London), Carole Ott (Paris) and Fernand Dimidschstein (Brussels) are Partners at Corporate Value Associates, David Thöni is an Associate Partner based in Berlin.