Banks might not have enough capital to keep credit flowing if the COVID-19 pandemic leads to an economic downturn on the same scale as the global financial crisis a decade ago, research from the Bank for International Settlements (BIS) said on Tuesday.
Banks started the COVID-19 crisis with roughly $5 trillion of capital above their mandatory minimum requirements, a bulletin from the BIS, a forum for central banks, said.
As the virus began spreading, regulators have allowed banks to tap some of the capital they hold above minimum requirements to ensure the continued flow of credit to companies and households struggling to stay afloat during national lockdowns.
More recently, banks in Europe and the United States have also, however, begun taking billions of dollars in provisions for souring loans as a deep recession looms.
The BIS bulletin said the amount of additional lending from banks will depend on how hard their capital is hit by the crisis, on their willingness to use the buffers, and on other policy support.
In an economic scenario similar to the great financial crisis (GFC) of a decade ago, banks would end up having about $270 billion in surplus capital above the minimum requirements, enough to support loans worth $1 trillion, the bulletin said, noting that only equates to about 1.3 per cent of total global loans.
“Overall, the analysis shows that, despite the build-up of capital over the past years, usable buffers alone might not be enough to bolster lending should the crisis deepen to a scale comparable to that of the GFC,” the paper said.
“In such a scenario, policy faces a difficult trade-off.”
There would be a need to preserve lending capacity throughout the pandemic, but also prevent capital ratios from falling to levels that could undermine the sector’s resilience, the bulletin said.
“Moreover, policy needs to strengthen the incentives for the sector to return to a sustainable path in the medium term, which includes accelerating consolidation and balance sheet repair.”
A Bank of England policymaker said last month that Britain’s economy could shrink by 13 per cent, its deepest recession in three centuries.
BoE Deputy Governor Sam Woods said on Monday that allowing UK banks to tap 23 billion pounds ($29 billion) in capital would support loans worth up to 190 billion pounds, which he said should be enough to accommodate even a top estimate of what will be needed.
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