The Impact of COVID-19 on the Global Financial Services Industry & Focus on Risk Management
The outbreak of COVID-19 has led to a significant upheaval in the world economy, and the financial services and banking industry is among the worst hit. Banks have a role to play as systemic stabilizers in these trying times and are at the heart of most economies. While rising debts and increasing loan applicants are a direct result of the crisis, banks will also have to walk a tightrope to remain profitable despite the increasing number of defaulters.
COVID-19 has caused multiple furloughs and lay-offs globally. Countries worldwide have been taking fiscal measures by introducing unprecedented economic stimulus packages to help their citizens tide over the crisis. Banks in the US saw increased lending in March to the tune of $191bn to public companies; however, they still face operational troubles. In Europe, banks in the UK, Italy, and Germany run the risk of being in the red, while Australia seems to have cashed up just before COVID-19, and can sail through till September.
This scenario is characteristic of a market that’s seeing low liquidity and low growth, which in turn is causing higher cut-offs, lower approval rates, and more restructuring in the current loans. Limited cash inflow has consumers stocking up on essential items and staying away from the purchase of luxury or non-essential goods. Regulatory bodies are trying their best to keep the economies afloat by focussing on loan restructuring or suspensions in collections. Banks and regulators are also adapting to the new lockdown policies by reducing the workforce and shutting down ATMs or bank branches in many areas, necessitating more digital transactions resulting in the rise of online fraud and phishing cases.
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Current Market Realities:
The Rise of Digital
As people steer away from traditional banking, it becomes imperative for banks to become digitized. Banks can switch over to digital customer acquisition, and include risk assessment and onboarding as part of this process. Implementing a dynamic and flexible business model, while looking for automation opportunities will continue to remain a priority for banks. Chatbots are an effective solution to managing customer support queries, planning wealth management goals, and helping banks improve efficiency, as well as providing personalized customer experiences.
According to Gartner, some commercial banks are looking into extending automated credit underwriting to deal with the surge in lending applications, and tracking COVID-19-related loan applications as separate categories.
Increase in Fraud
The dependence on digital can lead to an increase in fraudulent transactions, phishing, and other online fraud.
Banks need to look out for solutions that help tackle fraud loss by triggering alerts when seemingly contradictory spending patterns are observed. Using AI in such circumstances can help assess quantitative data and unstructured data systems, for better risk management of financial and reputational losses.
The Data Challenge
Banks and financial institutions have records of massive quantities of data, given that we’re living in the digital age. While historical data is frequently used for comparative studies and data modeling, COVID-19 poses an unprecedented challenge, as no reference can help compare to this scenario. This results in a high vulnerability in the current models used across lifecycles for consumers and commercial entities, and they might not be useful until they are rebuilt or recalibrated extensively. However, getting post-COVID data will be a challenge, and quarterly economic data will be of less use, and more granularity will be required by industry, geography, etc.
Banks can look at using portfolio loss and stress forecasting tools to create various forward-looking scenarios, using granular industry and geography data, and early signals from consumer portfolios. It helps to connect early performance with various scenario stimulators, using monthly macro trends and consumer behaviors to predict future loss stress in the portfolio.
Coping with the Increasing Number of Defaulters
Owing to the spread of COVID-19, consumer loans, specifically in credit cards, personal loans, and auto loans, are on the rise, and different industries will feel the impact in different manners. While highly elastic sectors (clothing, books, oil & gas) experience immediate repercussions, they will recover once the situation improves, and the lockdown is lifted. Less elastic industries such as aviation and tourism will be majorly affected due to continued loss of business. However, essential goods and hygiene will see an upsurge in demand, given more focus on personal health and hygiene, which will continue in the immediate future.
In these scenarios, the adaptability of banks to a fast-changing situation is a win-win situation for consumers and businesses. This can be done through identifying the right segments which are worsening, especially in early default and bounce segments. What banks need is a solution to help identify specific segments depending on the target KPI. This will help banks perform targeted credit line increase and decrease or select the right segments for cross sell and upsell.
Robust Norms and Restructuring for Loans
These unprecedented times will see banking clients face stretched financial conditions, affecting their credit quality/ratings. Retail and institutional borrowers may resort to minimal or delayed payments on their loan balances due to lower revenues. As the scenario worsens, banks need to lend responsibly to minimize future risk, while maintaining good credit growth.
Lower and stringent credit, along with the stressed economic environment, will lead to more restructured loans. At the same time, those industries which are doing better will take advantage of lower interest rate loans and will do balance transfers. Banks will turn to credit risk indicators that can help them identify positive or negative trends early on, and proactively strategize to improve their customer experience. They can also look at portfolio optimizers to reduce acquisition risk, while optimizing the revenue of the portfolio using different scenario estimators, to cater to the changing environment, while acquiring the right customers.
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Evaluating Credit Risk and Losses
Risk identification, monitoring, and measurement are key areas that banks and financial services need to focus on. Banks are increasingly relying on forecasting models to identify institutions that are at a high risk of defaulting in the future. They will need to follow stringent guidelines in identifying clients with higher vulnerabilities, determining creditworthiness, and deciding on potential credit-risk mitigating actions for pre-delinquency, early delinquency, and non-performing exposures.
In terms of collections, as a function, this can be done by segmenting customers based on risk and collection priority. Banks have to analyze their portfolio performance at a monthly granularity to identify dynamic risk areas. They also have to assess loss forecasting and reserving, based on new data sources. They need to track changing KPIs and anomalies when forecasts are failing.
Given these testing times, banks and institutions might also consider increasing their loan loss provisions. Essentially, these are expenses set aside in place of uncollected and loan payments and are used to cover potential loan losses, bad loans, and customer defaults. USA’s biggest banks JP Morgan, Citigroup, Bank of America, Wells Fargo & US Bancorp, have cumulatively stashed away $24 billion in loan loss provisions, five times more than the standard! Other banks globally may also need to take a leaf out of their books, to be ready for the growing list of defaulters in 2020.
Using AI-Powered Solutions in Financial Services & Banking
Experts predict that while many of the challenges are systemic, the financial services sector could meet some of the operational challenges and mitigate risks by using advanced analytics and AI solutions. At BRIDGEi2i, our team of expert data scientists have devised a range of advanced AI tools and applications to help enterprises tide over the crisis, keeping in mind the long-term goal of digital transformation.
“We are aware of the pain points due to our deep experience in this sector,” said Ashwini Agrawal, Director, FS, BRIDGEi2i. “We can help FS businesses devise strategies for the crisis to provide better customer experience, improved sales effectiveness, and enhanced governance and compliance processes, leveraging the power of data science and AI technologies.”
As banks and financial services attempt to come to terms with the new normal post COVID-19, there’s an inevitable need for transformation, majorly fueled by AI. Businesses will have to reimagine workplaces, re-prioritize risks, and look at optimizing resources while continuing to support the larger communities. Risk mitigation and crisis management are crucial to most enterprises’ business continuity plans. More on this here.
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Check out our video on using AI solutions in Financial Services to manage the downturn.