Banks get stressed like never before, globally

Banks are thankfully in much better shape to face the coronavirus pandemic than they were before the financial crisis. But as the economic challenge they face grows, regulatory measures to help them that looked overly forgiving just a few weeks ago may prove to be just the start.
In 2008-2009, the financial sector’s woes dragged down the real economy. Now it is the other way round. Supervisors are looking to financial institutions to be part of the solution to a real-world shock. Lenders on the whole are far better capitalised and their balance sheets included a good portion of easy-to-sell assets going into 2020.
As forecasts for the severity of the economic downturn are worsening, so are the prospects of banks coming through the crisis intact. Expectations for a sharp “V-shaped” recovery are fading amid the realisation that social distancing — and economic activity – will lead to a slump that could last several quarters. There is no visibility as to when or how quickly economic activity will resume.
Deutsche Bank AG analysts forecast an annualised GDP contraction of 24% in the euro area and 13% in the US in the second quarter. At this rate, the decline would be more than one and a half times greater than the financial crisis.
Even with considerably more equity than a decade ago, banks remain inherently levered institutions. Borrowings of banks from JPMorgan Chase & Co to Deutsche Bank AG to HSBC Holdings Plc exceed their capital by more than 15 times. Stress tests show the biggest lenders have sufficient capital, but it’s debatable whether these assessments capture the magnitude of the downturn ahead. Nor do they model the implications of the synchronised shutdown that is paralysing large, interconnected economies.
In the US stress tests last year, banks’ resilience was measured against a real GDP decline of 8% from the pre-recession peak and a surge in the CBOE Volatility Index (VIX) to 70. The index, often referred to as the fear gauge, soared past 80 last week for the first time since 2008.
The Institute of International Finance estimates that at $75 trillion non-financial corporate debt is worth around 93% of global gross domestic product, up from about 75% of GDP before the financial crisis, with some of the highest burdens in sectors with weak earnings, such as small and medium-sized companies.
Analysts at Goldman Sachs Group Inc estimate that if credit lines across travel, commodities and energy get fully drawn, the liquid assets held by the top US banks to cover draw-downs would come close to regulatory minimums. Executives from UBS Group AG, Credit Suisse Group AG and Deutsche Bank told a virtual conference they’re seeing clients drawing on credit lines, regardless of whether the cash is needed now.
To be sure, central banks and governments have raced to ramp up their stimulus and are taking steps to ensure credit keeps flowing to the economy. From cutting interest rates, to resurrecting a commercial paper backstop, in a matter of days the US Federal Reserve has gone through the financial crisis catalog of fixes. Even against that backdrop, banking supervisors rightly see the need to be accommodating with lenders. Post-crisis measures, some of which were designed to be eased in times of economic slowdown, are being rolled back. Banks will be allowed to let capital ratios fall — an inevitable function of assets going bad — and in Europe stress tests have been postponed.
—Bloomberg