COVID-19: a banking system redemption?

The Bank of England and the UK Treasury have taken drastic measures to respond to widely-expected disruption to the UK economy caused by coronavirus. All eyes are now on the banks.

On 11 March, the BoE and Treasury launched a series of co-ordinated measures designed to provide relief to individuals and businesses potentially affected by falling consumer demand or reduced productivity in the wake of the coronavirus pandemic.

The authorities have put in place a framework to incentivise increased lending to support the real economy. Now, it’s over to the banks. But can the response to the coronavirus be that simple? Let’s look first at how the day of 11 March unfolded.

The BoE fired first, announcing a 0.5 percentage point reduction in the Bank Rate to 0.25 per cent. The reduced rate reduces borrowing costs for businesses. But it also cuts borrowing costs for the Government; convenient given the Chancellor’s later announcement that Government borrowing will increase by £100bn over the next five years.

The BoE also launched a new Term Funding Scheme with particular incentives for small- and medium-sized enterprises (SMEs). The BoE will offer four-year funding of at least 5 per cent of banks’ lending to the real economy at interest rates at or close to Bank Rate. The BoE will make additional funding available to lenders that increase lending to SMEs.

The BoE estimates that the scheme will lead to around £100bn being provided in term funding. The scheme aims to transmit the effect of the reduced interest rate to the real economy, incentivising lenders to provide credit to businesses and households. The hope is that this credit will bridge a period of economic disruption and provide additional encouragement to lend to the SMEs that typically bear the brunt of contractions in credit supply during periods of heightened risk aversion and economic downturn.

The BoE also announced a reduction in the countercyclical capital buffer to zero per cent of banks’ exposures to UK borrowers until at least March 2022. In practice, this means that banks’ capital requirements for UK lending will be reduced by up to 2 percentage points. The BoE expects this to support up to £190bn of lending to UK businesses. This is equivalent to 13 times the amount of net lending to businesses in 2019.

Later in the afternoon of 11 March, the UK’s new Chancellor Rishi Sunak gave his maiden budget speech, announcing a range of measures to help individuals and businesses. A temporary Coronavirus Business Interruption Loan Scheme will see banks lend up to £1.2m to support SMEs with a government guarantee covering up to 80 per cent of losses. The Treasury estimates this will unlock up to £1bn of attractive working capital loans to support small businesses.

An opportunity to restore reputations?

All eyes are now on the banks. How will they react in these unprecedented circumstances and uncertain times? The authorities’ intent is clear. But banks must still run their business prudently. If banks relax lending criteria too much, they may suffer losses and face market and shareholder criticism.

The banking system is much more robust than a decade ago. Stress tests suggest that banks can withstand severe pressures. Banks will need to be brave and lend to businesses who may be in difficulty or to forebear from defaulting existing loans. On a day-to-day basis, these decisions will be made by credit or loan officers. These people will need support from senior management, who in turn will need to be confident of regulators’ support.

The measures are reminiscent of those put in place after the global financial crisis of 2008-9. Banks have been pilloried since then for their role in causing the crisis, for misconduct and for taking advantage of cheap money provided through quantitative easing. But, by lending to SMEs and others as authorities anticipate, banks could keep the economy going, performing the socially useful function they allegedly shirked during the last financial crisis.