The spread of the coronavirus and its accompanying shock to the global economic system has spurred widespread fear within the financial services sector. The disruption has led senior leaders at financial services firms to ask some basic questions, from how do we keep our employees safe, to what does our near-term financial health look like, to what if this crisis continues over the long-term. Are we equipped to remain operable?
The answers are not simple. But we can offer some guidance for navigating these increasingly treacherous waters.
What is happening?
The virus emerged late last year from the central Chinese city of Wuhan in the Hubei province and has since spread worldwide. There have been more than 115,000 confirmed cases of the virus as of Tuesday, with more than 4,000 deaths reported worldwide . In the United States, the outbreak has accelerated, and the Centers for Disease Control and Prevention has said that it’s only a matter of time before the virus spreads throughout the U.S.
What to watch?
The financial markets are flashing warning signs of recession brought about by the coronavirus and concern over slowing growth, so stakeholders in the financial services sector need to remain cautious. They need to ensure that they are monitoring appropriate indicators that aren’t reactive in the way that equity markets are. As the old adage goes, they need to respond, not react.
Market stress is showing up in the overall bond market …
One way that uncertainty shows up in credit markets is in widening credit spreads, which show decreasing confidence that a borrower will be able to repay outstanding credit. If repayment is called into question, credit would tighten as lenders become less willing to take on risk. Conversely, if growth prospects are improving, the opposite would hold true – a decrease in uncertainty will lead to narrowing credit spreads.
… and in the banking sector as well.
It’s for this reason that select spreads are viewed as an overall measure of the financial system’s health. Take the difference between LIBOR and the federal funds rate, or FRA/OIS spread. It provides a picture of the relative health of the banking sector. The more perceived risk there is with banks lending to other banks, the wider the spread. When banks see higher risk to lending to other institutions, the resulting impact is less liquidity within the market.
As the coronavirus has spread fear throughout global equity and credit markets, the consensus is that risk is increasing, resulting in the financial markets experiencing greater stress which will ultimately manifest itself as liquidity challenges to market participants.
What’s the business impact?
It will be imperative for businesses not only to follow guidance from the CDC to protect their employees, but also to take a holistic view of their enterprise to assess the risks and opportunities. These measures – which need to be taken across industries — include creating a team to monitor the health crisis, developing response plans and making sure that the right technology is in place to serve customers through digital channels and allow employees to work remotely.
In financial services, though, there are other risks that firms need to consider:
Regulatory and policy
- Monitor markets where operating for extensions on regulatory filings or other important notices.
- Evaluate fiscal responses to the crisis to see if there are opportunities for your organization to take advantage.
Credit and financing
- Analyze the portfolio to better understand current exposure with an eye on sectors that may be most affected over the near- and midterm, including leisure and hospitality, and industrial and consumer products.
- Anticipate a further tightening of credit markets, which may constrain sources of liquidity and evaluate other sources of liquidity through non-traditional avenues.
- Monitor interest rate movements and understand how both short-term and long-term changes will affect profitability.
- Mitigate balance sheet exposure by actively managing both sides of the balance sheet.
- Understand protocol to draw on emergency lines of credit.
- Review agreements to be aware of any covenants that require communications with all stakeholders.
- Work closely with intermediaries and other service providers to confirm that their communication and transaction systems are fully functioning.
- Explore use of alternative parties to conduct M&A activity or investor relations.
- Be prepared to route trading activity to alternative platforms in the event of exchange disruptions.
Budget and planning
- Review budgets to determine the impact of lower interest rates and slower growth brought about by declining consumer and commercial borrowing demand.
- Review current insurance coverage to assess adequacy.
- Consider investing in business intelligence tools.
Healthy organizations with strong capital and liquidity may have opportunities to expand in a downturn through acquisition or strategic partnerships.
As uncertain as the near-term future may look, executives who make prudent decisions, have planned for a downturn and continually monitor critical business processes and technologies will be better able to weather a downturn. For those that feel caught off-guard by recent market and economic events, hope is not lost. Now is a time to step into action and begin planning to ease the long-term impact on the bottom line.