Germany’s banks have achieved a great deal in the first weeks of the coronavirus crisis. They were able to provide thousands of companies with emergency government loans, thus protecting them from financial bottlenecks. However, zeb experts warn institutions against lulling themselves into too much state-guaranteed security: the longer the economy is paralyzed by the virus, the greater the risk that companies will slide into insolvency after all, thus putting banks at risk too.
 
“A wave of bankruptcies is building up which will sooner or later reach the credit portfolios of banks,” says Natalie Schneider, Partner at zeb and expert for operational credit business. This is also suggested by figures from the ifo Institute of Economic Research. According to an April survey, almost a third of the companies surveyed are threatened with closure after just three months, and more than half could survive for a maximum of six months under pandemic-induced restrictions. 

To prevent this, the state has set up aid programs. Between March 23 and May 8, banks processed more than 35,000 applications with a total volume of around EUR 33 billion for the special credit program of the federally owned KfW Bankengruppe. The state development bank assumes 80 to 100 percent of the default risk. According to estimates, the credit volume could still triple. 

But that alone is not sufficient. “Banks must be aware that special loans buy their customers time, but often no more than that,” says Helge Böschenbröker, Managing Director at zeb in Italy and expert for problem loan processing. “Sectors such as the hotel and restaurant industry are already at the limit despite that aid.” Also, many ailing companies, which only the good economic situation of recent years has kept alive, are likely to run into difficulties. “Customers will go into a tailspin despite special aids,” he warns.

Böschenbröker therefore compares the aid programs with a breakwater, which does take some of the intensity away. But: “In the long run, they will not prevent a dramatic increase in non-performing loans. The wave will come—the only question is: how high will it be?” 

That is why it is necessary to prepare early and protect oneself from the wave, the zeb managers advise. “No conventional risk model can correctly depict such scenarios in advance,” says Böschenbröker. Accordingly, banks should screen their loan portfolios for coronavirus-related risks with the help of specific models. This would enable them to help borrowers bridge liquidity bottlenecks in a systematic and targeted manner at an earlier stage. It is true that banks would not avoid all insolvencies in this way. But at least an all too drastic increase in non-performing loans within a short period of time would be prevented, say the zeb managers.
 
“Flattening the curve is therefore also recommended for the problem loan portfolio,” say Schneider and Böschenbröker, referring to the tour de force of politics and society to save the health system from an overwhelming flood of coronavirus cases by slowing down chains of infection. 

“An accumulation of bankruptcies and loan defaults will also turn into a problem for many banks,” warns Böschenbröker. For there are chains of infection in the real economy too. They extend along customer and supplier relationships—the insolvency of a company then carries the risk of “infecting” its business partners. Which is why, in the view of experts, financial institutions would also be well advised to flatten the curve. 

“An overly steep increase in problem loans inevitably leads to a lack of intensity in processing individual exposures. Among other things, this hinders the timely and in-depth analysis of the company’s situation and the effective application of forbearance measures. In the short term, this necessarily entails higher loan defaults and a corresponding need for risk provisioning,” explains the zeb manager.
 
However, according to the zeb experts, there are operational risks involved for the banks. For example, they see an increased risk of formal errors in applications. “It is still unclear to what extent possible formal errors can lead to a rejection of liability for the effective loss from settlement,” says Böschenbröker. 
 
In order to minimize risks and prepare for imminent issues, banks should focus primarily on personnel and processes. “Since the economic situation has been very positive in recent years, banks often lack valuable experience in dealing with problem loans,” says Böschenbröker. In his view, there are too few staff to deal with the expected caseload; in addition, staff are often not sufficiently trained for these specific issues. 

At the same time, it is important to optimize the processes. “Banks should prioritize clearly,” says Schneider. Among other things, it is necessary to decide which customers should be intensively supported, where restructuring appears justifiable and sensible, and for which customers settlement seems unavoidable. In view of the expected volume, options such as outsourcing settlement to external service providers or selling portfolios should also be considered. 

Either way, the risk profile of banks will change, according to the zeb duo: “Everybody needs to get stuck in now.” 

Read more on how to avoid defaults, apply forbearance etc. in our action program for dealing with the COVID-19 pandemic at #zebFutureProof