Banks will very shortly be confronted with an existential conundrum, with the conflicting, indeed antagonistic forces of survival and social responsibility pulling them apart. With global recession, business closures and redundancies imminent, banks will suffer huge defaults and credit losses over the coming months.
Meanwhile, in the short term, they will be expected to provide emergency liquidity to firms and individuals alike, grapple with an unquantifiable variable and, at the same time, be clever enough to ideate a strategy to remain profitable, retain their ratings, remain solvent and liquid and, most importantly, inspire confidence in depositors and creditors.
It is an enormously complex task, given to easy failure on one or more fronts. In 2008, banks were objects of derision, and abhorred for their failures due largely to greed; now failures are a real threat owing to a single virus.
No getting away
Regional banks will not escape the wrath of the virus. Credit losses are imminent as provisions mount over the coming months. Liquidity will reduce (both deposits and international funding) resulting in an increase in the cost of funds therefore creating an upward pressure on lending margins, combined with a rise in the cost of credit as defaults rise.
Basically, financing will become more expensive and far more stringent. The stringency will also extend to a lower threshold for tolerating delinquencies. Banks will be prepared to let companies die far more readily than before. They have little choice, as there is no possibility of free handouts to businesses.
A significant contraction in the top-line will also occur with new lending opportunities becoming scarcer, coupled with an aversion to risk-taking. Banks will be open to new business in the SME/corporate sectors, albeit selectively, focusing on industries to which government (stimulus) spending is directed, at least in 2020 and 2021.
As a result, banks will turn inward and take a very hard look at costs — severe measures of cost rationalisation should be expected. It is highly likely that the pace of bank mergers will accelerate.
Sifting through the lucky ones
So what should business enterprises do? Those that already are borrowers from banks are lucky — they can look forward to repayment respite; and if they have a case, even to additional money. The non-borrowers, however, deserving, are the hapless ones. Bank credit to this segment will be extremely hard to come by.
For those who are already reliant on banks for finance, you need to take a very long and hard look at long-term viability right now. The first step should be to make a realistic assessment of medium and long-term viability based on a worst-case scenario of the business environment, especially over 2020 and 2021. Business owners then need to work backwards to take immediate action for long-term sustainability.
Keep channels open
Second, start engaging with lenders to discuss this and the implications for financing … seeking professional help to ensure this is done and avoiding panic is a sound idea. The banks are unlikely to do this in a hurry as they have multiple issues to handle, as seen earlier. The ones who have borrowed large sums will be heard first!
Third, if your business is indeed viable in the long run, then start working on diversifying your funding sources — whether among banks or otherwise. Explore the insurance market for yourself as a borrower (to comfort bankers and suppliers) and for your receivables.
Fourth, start thinking of better capitalising your company — either by injecting your own capital or by seeking new partners and/or strategic equity alliances. Asking one to introduce new equity at this stage might seem a foolish thing to do, but whether you like it or not, banks are going to ask you to at some stage. So, you might as well pre-empt that and act early.
The new world will be one of larger, broader partnerships, enhanced governance, transparency and scrutiny, all around. Many of these suggestions may seem inapt for current times, even far-fetched, outrageous, contrarian and so on. They are not. For too long short-termism been the bane of this market. This is likely to change, coupled with a marked reduction in lenders’ tolerance of marginal credits.
Therefore, even if these suggestions seem inopportune and badly timed, events are headed this way. And if long-term survival is at the back of your mind, you would be well-advised to bring it to the forefront.
- Vikram Venkataram is Managing Director at Vianta Advisors.