Global Banks Country-By-Country 2021 Outlook:
Toughest Test For Banks Since 2009
Authors: Gavin Gunning, Emmanuel Volland, Alexandre Birry
A key risk is that economic disruption from COVID-19 gets worse or lasts longer than our base case of a sustainable economic recovery in 2021 and a widely available vaccine by mid-2021.
Additional tests to banks include overhangs from forbearance and other public supports, anticipated higher corporate insolvencies, and stress in property.
We believe many banking jurisdictions globally will not recover to pre-pandemic financial strength until 2023 or beyond.
This year has been hard for banks. Next year may be even harder. S&P Global Ratings believes 2021 could turn out to be the toughest test for banks since the aftermath of the global financial crisis. Supports that have steadied banks and helped borrowers survive cannot last forever. Their withdrawal will reveal a truer picture of underlying bank asset quality, even as economies start to recover. We likewise note, however, that the dynamics of the current downturn are different. Strong fiscal support for economies is benefiting banks, funding markets are accommodative, and in our view, banks are better equipped than they were in 2009 to withstand economic pressures.
Our ratings on the banks reflect the long road ahead. Since the onset of the pandemic, we have taken 236 negative rating actions on banks globally (as of Nov. 9, 2020). The majority of these were changes to negative outlooks or placements on CreditWatch negative (77%), though nearly a quarter were downgrades (23%). We have made negative revisions to about half of our 87 Banking Industry Country Risk Assessments (BICRAs). These include revisions to economic trends or industry trends, and in some cases downward adjustments to our country risk assessment itself.
Twelve months ago, before COVID-19 struck, banks faced the new year with relative calm. The scenario for banks heading toward 2021 is a sharp contrast. For many banking jurisdictions, we do not envisage recovery to pre-COVID-19 2019 levels until 2023 or beyond.
Shared Pain But Diversified Paths To Normalization
The recovery of banking jurisdictions globally to pre-COVID-19 2019 levels will be slow, uncertain, and highly variable across geographies. For 14 of the top 20 jurisdictions, we estimate that a return to pre-COVID-19 levels of financial strength won't occur until 2023 or beyond (see "Global Banking: Recovery Will Stretch To 2023 And Beyond," published on RatingsDirect on Sept. 23, 2020).
Some emerging market banks will have a difficult year in 2021, and many will struggle to recover quickly from the pandemic. An exception may be China, where recovery of the banking sector to pre-COVID-19 financial strength could be earlier. Even for potential early-exiter banking jurisdictions from COVID-19, such as China, we don't expect recovery until year-end 2022 (see chart 1).
We expect banks' financial profiles to worsen across many jurisdictions until the economic recovery takes hold. Even then, there will be a lag effect on banks' credit profiles before they improve as they work through asset quality difficulties. For banks globally, we estimate the pandemic will help drive credit losses of about $2.1 trillion by year-end 2021 (see "The $2 Trillion Question: What's On The Horizon For Bank Credit Losses," July 9, 2020). This will mostly be on the back of souring corporate and personal sector loans.
While profitability will stay depressed in 2021, many banks overall are in better shape to withstand stress compared with 2009. They are better capitalized and less leveraged, due largely to tougher standards implemented in the wake of the global financial crisis, and have significant provisioning levels to buffer weaker asset quality. Furthermore, funding markets are stable. Nonetheless, our negative outlooks on about one-third of banking groups globally reflect our view of uncertainties and risks in the coming year. We see four key risks to watch.
Key Risk #1--Economic Disruption From COVID-19 Gets Worse Or Lasts Longer
A widely available vaccine from mid-2021 and a strong economic recovery next year is our central premise. While negative pressure on bank ratings will persist until a meaningful and enduring economic recovery can take hold, most bank ratings may hold at current levels if our base case unfolds as envisaged. Should the economic malaise because of COVID-19 become worse or last longer outside the boundaries of our base case (see table 1; and “Global Debt Leverage: Risks Rise, But Near-Term Crisis Unlikely," Oct. 27, 2020), however, then we can plausibly expect a negative step-change in bank credit quality in 2021.
The health crisis and consequent economic recovery is likely to continue to be variable across geographies in 2021. Several noteworthy differences are already evident heading toward 2021 (see chart 2). In some high income economies (mainly in Asia) the virus is currently contained with zero (or close to zero) new infections and deaths; however, significant constraints on borders, mobility, and social gatherings will continue to hinder the economic recovery. In some other high income economies, notably the U.S. and in Western Europe, the virus is resurging.
Many emerging economies are challenged to contain the virus and we expect recovery of some banking systems to pre-pandemic levels will be slow. Furthermore, on the pathway to recovery, factors influencing emerging markets' bank credit quality may be volatile.
Key Risk #2--Short-Term Support To Banks And Borrowers May Leave Longer-Term Overhangs
Public authorities have acted swiftly and decisively in responding to COVID-19 by providing unprecedented levels of fiscal support as well as significant funding and other support, particularly in advanced economies (see chart 3; and "Global Credit Conditions: The K Shaped Recovery," Oct. 7, 2020). Support measures have largely counterbalanced the effect on bank credit as significant economic volatility flowed through to bank borrowers.
Well-conceptualized and well-timed actions by authorities will be critical in 2021. Should monetary and fiscal stimulus diminish too early then a drawn-out recovery is likely. This could result in more damage to households and corporate balance sheets--and consequently to banks.
Public authorities must contend with a delicate balancing act, however. Measures that benefit banks in the short term could contribute to an overhang of household and corporate debt not commercially bankable in normal times, or introduce moral hazard by encouraging banks to relax lending standards or misprice risks, among other vulnerabilities (see "Five Dangers For Credit Markets Awash With Liquidity," Oct. 29, 2020). Banks are likely to be facing years of lower profitability due to the squeeze on interest margins in an environment of ultra-low interest rates.
A continuation of orderly funding and derivatives markets will be vital for banks to navigate the lingering effects of COVID-19. While not our base case, any major disruptions in funding or derivatives markets would compound adversity for banks.
Key Risk #3--Surge In Leverage And Anticipated Higher Corporate Insolvencies
The ongoing surge in corporate leverage and expected higher corporate defaults in 2021 will pose a material risks for banks. While banks are constrained by prudential guidelines including limits on their own leverage, we anticipate potential adverse spillover effects from heavy corporate borrowing in both the bond and bank markets at a time when earnings are under enormous pressure in many industries. Furthermore, some businesses may be less commercially viable in a post-pandemic world due to structural changes in consumer behavior. Many companies will have to substantially adjust their business models in the new business environment.
We expect global corporate debt to surge to an average 103% of GDP in 2020 (from 89% in 2019), and government debt to 97% of GDP (from 82% in 2019), before a moderate deleveraging (see chart 4; and "Global Debt Leverage: Risks Rise, But Near-Term Crisis Unlikely," Oct. 27, 2020). This higher stress is indicated our baseline for the 12-month trailing speculative-grade corporate default rate, which we expect to double in the U.S. (to 12.5% by June 2021, from 6.3% in September 2020) and Europe (to 8.5%, from 4.3%) (see "Global Debt Leverage: Risks Rise, But Near-Term Crisis Unlikely," Oct. 27, 2020).
We fully expect that bank asset quality and profitability (taking into account high credit costs and low interest margins) will remain under significant pressure in 2021. Despite the surge in provisioning in 2020, based on banks' expectation of increased nonperforming assets, we see a risk that further top-ups will be required. Lower profitability will continue to translate into weaker internal capital generation.
Higher government leverage has the potential to constrain the future capacity, if not the willingness, of some sovereigns to provide extraordinary support for systemically important banks, in the event it were required. For banking jurisdictions where we currently factor government support into bank ratings, however, we do not anticipate any material diminution in supportiveness over 2021.
Key Risk #4--Property: The Age-Old Nemesis For Bank Credit
Borrower repayment moratoriums, forbearance by landlords in some jurisdictions, renegotiation of borrower arrangements by banks, and record low interest rates may be masking underlying asset quality problems. We think this is particularly the case for property, where banks typically maintain high security levels and can contend with short-term or temporary borrower cash flow difficulties. Furthermore, COVID-19 is accelerating pre-existing threats in segments of the commercial property market, such as retail malls challenged by online shopping. The office sector faces structural changes that could arise if work-from-home trends prove enduring. We see increasing risks in 2021 of commercial property risks potentially hitting banks' asset quality.
Additionally, there is a risk in certain markets that repayment holidays and wage subsidies could be delaying trouble that won't crystalize until support diminishes or is withdrawn. This includes borrowers' residential property assets used to secure small business operations and for investment purposes. One positive for banks is that residential property prices have held up quite well globally across many markets, allaying some concerns regarding a more pronounced fall in prices at the onset of the pandemic. In addition, borrower affordability will continue to be supported in 2021 by low interest rates.
Insights from rated transactions in commercial mortgage backed securities (CMBS) offer some visibility--though the view is not great. Stresses in the commercial property sector for transactions in rated pools may point to impending asset quality issues for banks with commercial property exposures on their balance sheets. A recent review of U.S. CMBS ratings resulted in 185 downgrades, comprising 88 single-asset/single-borrower (SASB) and large loan classes, and 97 conduit classes. In European CMBS since the COVID-19 outbreak, we've taken actions on about 20% of rated transactions. (see charts 5-6; and "U.S. And European CMBS COVID-19 Impact: Retail And Lodging Are The Hardest Hit," Sept. 28, 2020). Rating actions were most severe in the SASB subsector backed by retail malls--a sector which is experiencing considerable stress on several fronts.
Other Risks on the Radar
While we highlight four critical risks, there are numerous other tests for bank credit quality in 2021 and beyond.
– EM vulnerability: Emerging market banking systems are exposed, by varying degrees, to local economies' heavy reliance on external funding, concentration on specific sectors (such as the hospitality sector or industrial or service exports to developed countries) or commodities (such as oil or gas). Another vulnerability in some countries is the lack of government capacity to continue providing meaningful support. Further headwinds include the impact of lower interest rates on interest margins and lower lending growth on profitability (noting that interest margins are typically higher compared with developed markets), increasing credit costs as regulatory forbearance measures are progressively lifted, and potential challenges refinancing external debt for some jurisdictions. We also expect to see a greater divergence in the performance of the larger and smaller banks in some of these markets.
- Digital disruption: The prospects for digital disruption to incumbent banks is increasing. Potential step-changes in digital technologies could have a profound impact on how intermediation plays out between savers and investors, and public authorities and citizens, among other spheres. In turn, this could affect competitive dynamics--or other key risk factors--for banks. However, we also emphasize that digital disruption is ushering in many opportunities for banks in meeting customers' evolving expectations, while at the same time assisting banks to expand and diversify revenues, and control costs. Investment in new technologies has enabled banks to offer a quality service to customers despite the various containment measures that have severely disrupted other businesses. We see that COVID-19 is accelerating innovation and digitalization of many banking markets. 2021 could see the further major developments, including the ongoing exploration by central banks of opportunities related to digital currencies. The central banks of Sweden, Canada, Switzerland, the U.K., and Japan, plus the European Central Bank, have formed a working group with the Bank for International Settlements to share findings as each investigates potential cases for central bank digital currencies (CBDCs). They have already published views on the principles and key features of CBDCs as well as the necessary infrastructure. In China, the central bank has given away Chinese renminbi 10 million (US$1.5 million) of digital currency in a public test of the digital renminbi payment system. As well as exploration on e-currencies, we expect banks to materially invest into technology platforms including cloud transformation to streamline back-end processes.
– ESG: Investors and their stakeholders now demand more clarity on environmental, social, and governance (ESG) issues for decision-making. While key ESG considerations have always been integral in ratings decision-making concerning banks, this trend is likely to gain even further traction, driving increasing ratings diversification. Similar to digitization, ESG presents rewards as well as risks for banks that can skillfully navigate the ESG landscape in 2021 and longer term.
– Geopolitics: Economic nationalism and geopolitical tensions constitute one of the top risks (see "Global Credit Conditions: The K Shaped Recovery", Oct. 7, 2020). The U.S.-China strategic confrontation is important for bank credit quality in many economies, not just the U.S. and China. This dispute has implications for large global manufacturing economies and their banking sectors, such as Germany and Japan; as well as primary producer and mineral-exporting economies.
– New benchmark rates: The planned introduction of new interest rate benchmarks in 2022 is another critical development worth monitoring, as banks transition. Management of related operational, commercial, legal, and financial risks will be key.
A Note On Our Coronavirus Assumptions
S&P Global Ratings believes there remains a high degree of uncertainty about the evolution of the coronavirus pandemic. Reports that at least one experimental vaccine is highly effective and might gain initial approval by the end of the year are promising, but this is merely the first step toward a return to social and economic normality; equally critical is the widespread availability of effective immunization, which could come by the middle of next year. We use this assumption in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.
The table below presents S&P Global Ratings' views on key risks and risk trends for banking sectors in countries where we rate banks. For more detailed information, please refer to the latest Banking Industry Country Risk Assessment (BICRA) on a given country. According to our methodology, BICRAs fall into groups from '1' to '10', ranging from what we view as the lowest-risk banking systems (group '1') to the highest-risk (group '10').