Banks braced as pandemic poses biggest test since financial crisis

During the depths of the coronavirus crisis in Europe in late March, Sergio Ermotti remembers sitting in his home study in Lugano, reflecting on the latest financial meltdown to engulf his career as a banker.

"If I go through my last eight years, we had a lot of mini-earthquakes, but never of the magnitude of what we are seeing now," the 60-year-old UBS chief executive says. "This is a crisis that is driven by fear in a different way this time it's not just about people losing their assets or savings, it's about their life, it's about their families. It's so profound, so different."

Switzerland's largest bank is weathering the crisis relatively well, considering its share price is down only 10 per cent this year, a more modest fall than any other global lender apart from Wall Street's Morgan Stanley. This is no accident. Both have built wealth management arms that boast more than $2tn of client assets, generating consistent fees from the wealthy and super-rich desperate for advice on how to trade the pandemic.

The rest of the industry - particularly those focused on bread and butter lending to small businesses and consumers - are facing their toughest test since the financial crisis of 2008, as untold millions of companies face bankruptcy amid unprecedented global lockdowns and travel bans.

Governments and regulators have unleashed trillions of dollars of support measures to prop up the system, ensuring the flow of credit and functioning of markets, and helping households stay afloat with salary supports and repayment holidays. But many of those schemes are set to be withdrawn.

Meanwhile, interest rates that were already negative in the eurozone have been slashed to zero in the US and 0.1 per cent in the UK, piling pressure on banks' already slim lending margins.For the smallest and weakest still struggling to recover from the cataclysm 12 years ago, coronavirus could prove fatal. For the biggest, it portends a period of hand-to-mouth survival - weak profits, no dividends and much lower, or no, bonuses - at a time when most investors had already turned bearish.

As ever, Europe's banks have suffered far more than their US rivals, which have fatter profits to see them through leaner years.

Navigating the disruption has been complicated by up to 90 per cent of staff working from home for months on end.

"For the large national banks, facing zero interest rates into the foreseeable future and the significant credit exposure, how can one be confident?" asks Bob Diamond, who ran Barclays during the last crisis. "Please explain to me where earnings are coming from?" Vast credit losses are the primary concern. Six months into Covid-19, the numbers are already staggering. The 15largest US banks have set aside $76bn to cover projected bad debts and their 32-biggest European cousins €56bn, Citigroup data shows.

The combined total of $139bn in loan-loss provisions is the highest since the $186bn reached in the second half of 2009, the nadir of the financial crisis that brought down Bear Stearns and Lehman Brothers. Using a wider sample of banks, consultants at Accenture warn that the estimated losses from bad debts could rise to $880bn by the end of 2022.

Loan-loss provisions have been increased by new global accounting rules - a consequence of the financial crisis - forcing lenders to build reserves well in advance of defaults, particularly in the US where they must now provide for lifetime losses based on the latest economic outlook.

Vikram Pandit, Citigroup chief executive between 2007 and 2012, argues that this time like- for- like losses should be lower because consumers learned from the "tough times" they endured 12 years ago. "They are being quite prudent, they're using some of this money they're getting from the government to pay down debt, to reduce their balances, they're spending a little bit less," he says. Banks will not bear the full brunt of escalating defaults. The UK government's emergency small-business lending programme - where as many as half of the "bounce back" loans, with a combined cost of at least £34bn, are not expected to be repaid puts taxpayers on the line for losses.

Payment holidays on credit cards, mortgages and rents are also masking the current stress on loan books. JPMorgan wrote off just $1.6bn of loans in its $998bn lending portfolio in its secondquarter results.