Economies have gone on to a war footing: manufacturers are retooling factories to supply the needs of governments, workers are being mobilised and reallocated to areas of shortages. The financial sector must, likewise, adjust to the new reality. Banks will bear a large part of the burden that will come from the economic disruption of the coronavirus pandemic. They will need to support lending to households, businesses and large corporates. To weather the storm, they must build their balance sheets into fortresses and use every means to shore up capital.
The banking sector already serves a quasi-public function. It provides public infrastructure: the money supply and the payment system. And it is intertwined with the state through central banks and deposit insurance. As the 2008 financial crisis revealed, the government will ultimately provide a backstop in the event of a catastrophic failure, even if regulatory changes since then have focused on maximising alternative private-sector safeguards.
This places a strong moral obligation on banks to make themselves as secure as possible through this crisis. That means ensuring funds are used to support lending and not to reward shareholders, many of whom are similarly more interested in the long-term survivability of the companies than a short-term payment. Banks must cancel dividends and share buybacks. A similar argument applies to all companies whose balance sheets are threatened by this crisis.
The banking sector is already in a better position than it was during the financial crisis. Leverage is lower and capital ratios are higher.
Yet those measures may be insufficient as borrowers default and a broader writedown of asset values becomes inevitable. Regulators have already relaxed or tweaked requirements in the US, the eurozone and the UK so that banks can use capital buffers rather than curtail lending.
The European Central Bank has instructed lenders to cancel all measures to return funds to shareholders. The central bank estimates this will free up €30bn of additional capital to help support lending. It will also ensure that banks cannot take advantage of relaxed capital requirements to return funds to shareholders.
Regulators in the US and the UK should follow their example. British banks such as Barclays and HSBC are scheduled to make dividend payments over the coming days and weeks. Even if regulators do not act, chief executives and boards unilaterally should make capital preservation a priority. Some bond payouts will be able to be suspended. Bonus payments and share options should also be examined. Senior managers at Spanish bank BBVA have already foregone any bonus for 2020, worth €50m. Santander’s top executives are taking a 50 per cent pay cut.
Some banks may yet require an injection of public funds, depending on how long the shutdown lasts and how deep any economic downturn ends up being. Taxpayers and politicians are unlikely to look kindly on those who missed an opportunity to shore up their own balance sheets.
The French government has said that all companies, not just banks, that make dividend payments or buy back shares will be ineligible for any state aid. In the US, public anger is already directed at airlines that used their free cash flow in the good years to buy back shares rather than reinforcing their positions.
Banks were central to the financial crisis in 2008. Twelve years on, they must grasp the opportunity to ensure they are not only part of the solution, but are seen to be so.
Get alerts on Banks when a new story is published