EFFECT OF COVID-19 ON BANKING SYSTEM IN NIGERIA
REVIEW OF RELATED LITERATURE
Mapping the COVID-19 implications for banks
Since the COVID-19 pandemic is a novel experience for the world, the literature regarding its implications for banks is still developing. Yet, lessons from globally spilled-over systemic financial crises such as the global financial crisis (GFC) of 2008 could have some relevance, particularly because the effects are likely to be similar. Systemic events external to the banking system such as economic recessions, pandemics, war, political unrest, and environmental disasters could have massive adverse effects on the firm value and performance of banks, forcing many to fail or go bankrupt in extreme cases. The 2008–09 GFC is such a phenomenon, during which many cited ‘epidemiology’ as a reference point to explain the spillover of volatility and financial and economic distress situations through an intra-financial system, considering that the crisis outcomes are contagious like a pandemic (Caballero and Simsek 2009; Roubini 2008). The comparison argues that the outbreak and spillover effects of systemic economic and financial crises spread fast through both the intra-financial and inter-financial systems approach. Because of this nature, global or large-scale systemic crises could be termed as contagious just like the COVID-19 pandemic (Cecchetti and Schoenholtz 2020; Bachman 2020). As such, financial bubbles behave like disease pandemics and they should be treated the same way (Shiller 2020; Haldane and May 2011).
Disease pandemics such as COVID-19 produce a complex and diverse set of consequences for banks and threaten banking system stability (FSB 2020; Aldasoro et al. 2020). Figure 1 shows the mapping of possible implications of the COVID-19 pandemic for banks in a ‘no policy intervention’ scenario. The prevalence of the pandemic for a prolonged period with a subsequent complete lockdown may push banks to an inevitable crisis. Across economies, as an immediate shock of the lockdown and social distancing measures in response to the pandemic, production has halted, demand for goods and services—mainly for non-essentials—has slumped, factories and offices are completely or partly shut-down, transports and logistics are restricted, and public movement as a whole is highly restricted domestically and internationally (Barua 2020a, b).
Mapping the impacts of the COVID-19 pandemic for banks
Many of the immediate shocks turn out to be long-lasting over time, as countries continue enforcing lockdowns and strict social distancing over a longer period to curb the virus’s spread. For instance, it has been over eight months to date that such measures have been widely and strictly enforced across almost all economies of the world. The worldwide lockdowns and economic shocks in turn cause a severe disruption in the international trade of goods and services, due to reduced import demand internationally, limited movement of international transport and logistics carriers, and stricter entry requirements of goods and people imposed by many countries (Barua 2020b; WTO 2020; OECD 2020b; Rigden 2020). These have already started to generate severe macroeconomic costs for many nations through a sustained fall in aggregate demand and supply, slump in price levels, massive layoffs and job cuts, unfavorable exchange rate movement, and increases in risk and uncertainty for current or potential private-sector investments (World Bank 2020b).
Because of the diverse macroeconomic shocks, bank borrowers—individuals and firms—face high risk of default (Vidovic and Tamminaina 2020). The banking sector may see a steep rise in default risk and rates because of reduced incomes and cash inflows to their borrowers due to the economic slow-down and forced shutdown. The crisis will be worse for borrowers relying on exports to the international market, as the world economy struggles to survive from the pandemic. These effects will also be severe for small businesses whose only lifeline is doing day-to-day business and generating enough operating cash inflows to survive (Dua et al. 2020). Also, small businesses have little capital support and cushion to protect them from economic adversities. During and after the pandemic, banks that have a substantial lending exposure, particularly to export-oriented industries and small businesses, may see a steep rise in default rates. Further, the overall situation may turn many borrowers into willful defaulters and may increase the credit risk of the banks. It is possible that the market value of collaterals provided against secured loans may decline in value, further enhancing the credit and default risk for banks (Baret et al. 2020).
In addition to default risk, banks may also face liquidity crises as many depositors may choose to withdraw their savings to support their living and health expenses (Baret et al. 2020). Due to the pandemic, income opportunities for people and firms have become increasingly limited, which might force them to spend their savings. In particular, people losing jobs will desperately try to survive on their savings. This, if continued for too long, will cause liquidity shortage and limit the lending capacity of banks (Cheney et al. 2020).
Due to economic slow-down domestically and globally, demand for loans will slump, as is already happening in many economies. As firms limit their operation and production, demand for both short- and long-term financing declines substantially with no possibility of rebound until the economy as a whole recovers (Ryan et al. 2020). It will hurt banks’ basic business model and revenue generation and could create a large revenue shock in countries where lending dominates the business portfolio of banks, as is the case for many developing and emerging economies. The problem could be further intensified by the limits in lending capacity faced by banks due to liquidity shortage because of increased withdrawals (Cheney et al. 2020). Furthermore, incomes from both interest and non-interest sources are likely to fall due to a reduced international trade, foreign exchange dealing, and transaction services. Interest incomes could further fall as banks in many countries have already commenced waiving fees and charges, increasing credit card limits, granting mortgage payment holidays and access to fixed saving accounts in an effort to help their clients survive the pandemic (Ryan et al. 2020; Yousufani et al. 2020).
Much of the cumulative outcome of the affects discussed so far will be increases in NPLs and a reduction in asset quality for banks. A persistent scenario like this would necessarily lower the asset value or firm value of banks. A lower risk-weighted value of assets will in turn lower capital adequacy of banks, threatening the banks’ financial solvency, survival, and sustainability. The capital adequacy of banks could also decline as many banks could try to utilize part of their Tier 1 or 2 capitals to support their operating and financial sustainability.
After the 2008–09 global financial crisis, regulators across the world emphasized the idea that banks should hold substantial buffers to survive through dramatic downturns. To make it effective, the Basel Committee issued an enhanced capital adequacy (BASEL-III) accord to improve the banking sector’s ability to absorb shocks arising from financial and economic stress (BIS 2017). However, lessons from the large-scale financial crises remain mostly unheard, particularly in developing and emerging economies where banks aggressively compete. In addition, in many developing and/or emerging economies, financial markets are weakly efficient, suffer from insufficient regulatory infrastructure, lack innovation and adoption of cutting-edge technology, and are crippled with moral hazards and adverse selection problems driven by political interventions (Görg et al. 2020; Dominguez et al. 2009). The COVID-19 pandemic is likely to make things significantly worse in these countries. As a case of such emerging economies, this paper examines the possible impacts of the pandemic on Bangladesh’s banking sector.