Most Banks Will Be Able to Absorb Losses, but There Is a Weak Tail-IMF

The International Monetary Fund (IMF) has indicated that most banks have stronger “capital and liquidity buffers,” putting them in a position where they will be able to absorb losses amidst the COVID-19 pandemic, but “there is a weak tail”.

“Thanks to regulatory reforms,” banks entered the COVID-19 crisis with access to enough resources and continues to remain liquid compared to the global financial crises, which sparked up in 2008, the IMF remarked.

The IMF intimated that “policies aimed at supporting borrowers and at encouraging banks to use the flexibility built into the regulatory framework have likely further supported their willingness to continue to provide credit to the economy”.

Banks in some countries, however, have begun “tightening their lending standards in response to deterioration in economic conditions and borrowers’ financial positions,” the IMF opined.

To test the resilience of the banking sector to determine its likelihood to absorb losses as the crises persist, the World Economic Outlook (WEO) analyzed bank solvency using two scenarios, namely, the baseline and adverse scenarios.

“The analysis is carried out for about 350 banks accounting for about 75 percent of global banking assets. The largest banks covering up to 80 percent of banking assets are included”.

“In the baseline scenario, most banks are able to absorb losses and maintain capital buffers above the minimum regulatory capital requirements. In the adverse scenario, characterized by a deeper recession and a weaker recovery, there is a sizable weak tail of banks whose capital falls below regulatory minimum”.

“In the October 2020 WEO adverse scenario, the capital shortfall relative to minimum capital requirements is about $110 billion, whereas the overall capital shortfall relative to broad capital requirements—which include the countercyclical capital buffer, the capital conservation buffer, and systemic risk buffers—could reach $220 billion, after accounting for policy support. This implies that the average capital shortfall in the adverse scenario is close to 1 percent of GDP. For comparison, the median government bank recapitalization during the global financial crisis was about 3.6 percent of GDP”.

The IMF report further asserted that “global systemically important banks tend to fare better, while banks in emerging markets appear to be less resilient than their peers in advanced economies”.

“Looking ahead, the resilience of banks will depend on the depth and duration of the COVID-19 recession, governments’ ability to continue to support the private sector, and the pace of loss recognition,” the IMF added.

In concluding, the IMF made it known that “the full fiscal cost of ensuring that banks are adequately capitalized must also include the direct fiscal support to firms and households, which effectively reduced bank recapitalization needs ex ante, and which may also adversely affect the fiscal capacity to provide additional support in the future if needed. Furthermore, a more severe adverse scenario that would entail larger losses for the banking sector cannot be ruled out, given the high degree of uncertainty around the depth and duration of the COVID-19 recession”.