What the ‘New Normal’ Might Look Like in Banking (Brace Yourself)

The economic fallout from the coronavirus pandemic will impact credit quality, loan demand, deposit growth, fee income and much more. It also raises two key questions for banks and credit unions: Will the accelerated migration to digital channels 'stick,' and if it doesn't, and many people return to branches, can financial institutions afford to keep them open?

Every time the long-running U.S. economic expansion was predicted to wane, it would rally and continue longer, eventually lasting a decade. That’s how the year began. Now we have 26 million people filing for unemployment through April 23.

There’s no positive spin you can put on that stark figure. The impact will be felt by every financial institution in the land in some way. How they react; steps they take now to prepare for the impact — whether it be brief and intense or long and drawn out — will be of the utmost importance for not only institutions and their employees, but the consumers and businesses they serve.

The bank research and consulting firm Bancography each year releases an industry outlook focusing on broad trends impacting retail banking. This year’s report was about to be published when the pandemic hit the U.S. in a rolling wave “upending all projections for the U.S. economy, including the banking sector,” as the report’s introduction states. Rather than just send it out with a note saying “Everything just changed,” the firm dug in and added a 23-page section analyzing the possible impact of the crisis and, importantly, offering suggestions for how banks and credit unions can prepare for whatever unfolds.

The first part of the report, “Where we’ve been,” is largely charts and graphs spread over about 30 pages, reviewing trends through 2019. The second section, “Where we’re headed,” looks at the possible impact of a pandemic recession on credit quality, deposit and loan demand, and channel use. This article summarizes key points from the second part.

What the Likely Near-Term Challenges Will Be

The “what’s ahead” part of the Bancography report begins with a sobering assessment. Even with government stimulus programs in the trillions of dollars and enhanced unemployment benefits, the impact of having 26 million Americans out of work, coupled with the closure of much of the retail and service sectors, will bring pervasive damage to not just consumers but to banks and credit unions, it states.

Here are some specific points that flesh out that prediction:

  • The industry entered the crisis period already on the cusp of some credit challenges. Delinquencies in credit cards and auto loans have been rising for several years.
  • There are two upheavals going on: the COVID-19 crisis and plummeting oil prices. The oil downturn will hurt wide swaths of the U.S. economy.
  • Government actions to mitigate consumer pain may push the problem upstream. Rent deferments, for example, could lead to defaults of investment property owners. Mortgage forbearance will adversely impact servicing firms and holders of mortgage-backed securities.
  • CARES Act mortgage forbearance does not cover non-conforming loans and other private-backed loans banks carry in portfolio. These account for 37% of U.S. residential mortgage balances.
  • Bankruptcies in the retail sector, already beginning, will further strain shopping center owners, in turn pressuring commercial real estate portfolios.
  • In addition to a likely jump in credit losses, financial institutions will face an erosion of interest revenue. The experience of the 2008-9 recession suggests that consumers, once chastened by life-altering events, hesitate to borrow again for a year or longer.
  • The loan slowdown will affect origination fees, and late fees will either dry up or be prohibited, along with overdraft fees.

There is one big plus in this otherwise gloomy outlook. As the Bancography report notes, the banking industry, in contrast to the financial crisis of 2008, enters the COVID-induced recession well-capitalized and prepared for shocks. The stress tests, Basel ratios, and myriad Dodd-Frank requirements that gave the industry fits for years have helped prepare it for what looks to be a major test.

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Suggestions for How to Meet the Challenges

The Bancography report’s authors state that banks and credit unions should “understand and accept the disruption will not be temporary. There is no ‘light switch’ that will instantly restart the economy at the point where it entered the crisis.”

“There is no light switch that will instantly restart the economy at the point where it entered the crisis.”

The reality is that the Paycheck Protection Program — amounting to over $600 billion in loans/grants — arrived too late for many small enterprises and their employees, the report states. In addition, for the firms that already dismissed or furloughed workers, restarts will likely be tentative — e.g. “We furloughed ten employees, we’ll start back with five and see how it goes.”

If revenues remain depressed for some time, banks and credit unions will have to reduce expenses in order to maintain earnings. This raises two key questions:

  1. Will the behavioral changes forced by the COVID-19 outbreak persist, accelerating a migration to digital channels, or will consumers starved for human contact rediscover the benefits of face-to-face interactions?
  2. Even if branch use returns to pre-crisis levels, can financial institutions afford to operate their branch networks while maintaining historic service levels?

The answers to those questions are speculative, Bancography points out. As a result, financial institutions have to plan for several potential outcomes. Nevertheless, the company states that “It seems plausible to presume that the longer the outbreak persists, the more ingrained new habits become, and the less likely consumers would then revert to pre-crisis behaviors.”

“Banks and credit unions should view the duration of the viral outbreak as a stress test for their institutions’ channels.”

Even if the crisis does not accelerate migration to digital channels, it demonstrates the importance of a consistent service experience across all channels, the report emphasizes. Banks and credit unions “should view the duration of the viral outbreak as a stress test for their institutions’ channels, and most critically, take observations for improvement along the way.”

As part of evaluating retail banking channels, Bancography urges bankers not to neglect the call center, especially since many call center inquiries now involve questions about the online channel.

In addition, the company believes consumers and small business owners alike will embrace personalized, customized financial assistance from a trusted advisor, especially now. In particular, helping customers navigate the array of governmental programs that emerge to combat the crisis would be a great service that financial institutions could provide.

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Planning for a Revised Branch Scenario

If the COVID crisis converts what had been a gradual shift from branch to remote channels to a sudden, acute shift, banks and credit unions may need to accelerate branch contractions. Even if there is not a sudden shift, the report predicts, the expected revenue declines may require reducing branch-network costs.

“Financial institutions should be prioritizing branches and markets by value, parsing the expendable from the indispensable.”

Financial institutions “should be prioritizing branches and markets by value, parsing the expendable from the indispensable.” That may involve exiting markets with low market share, retrenching around a few “strongholds.” Even in such strongholds, some branches may need to be downsized to ATM/drive-through-only configurations, in an exaggerated hub-and-spoke model, Bancography states. Leases and other factors may result in write-downs, but in a period of battered earnings, shareholders may overlook that.

Within surviving branches, staffing levels should be revisited, and investments made in equipment to facilitate reduced-staff operations, such as teller cash recyclers and interactive teller machines (ITMs).

There Is a Case for Expansion

On the other hand, judicious branch expansion can still prove beneficial, the report maintains, especially as a recessionary economy will afford lower land, lease and construction costs to opportunistic buyers. Also, expansion in a down economy, if possible, can bring a boost to an institution’s reputation.

A recession will create opportunity for smaller institutions to amass the scale critical for success, Bancography believes, especially within larger markets. The firm urges banks and credit unions to seek in-market merger partners to achieve cost-efficiencies from consolidation of overlapping branches, and to build branch density in core markets.

On the other hand, mergers that would bring only toehold presences in new markets, absent a growing underlying economy, would be unlikely to “leverage the benefits of the network effect,” the report states.

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Don’t Neglect the Lower-Income Market

A section of the Bancography report focuses on a defining aspect of the pandemic: The disproportionate impact on lower-income consumers both economically and in terms of health.

“The crisis has ravaged low-income households through actual infection rates, as many lower-income individuals work in more exposed professions,” the company states, “and many others worked in retail and service sector businesses that were among the first to close.” Many consumers in this situation also lack back-up savings, which highlights the needs, “for bankers to marshal any resources possible to mitigate adverse impacts in the working-class market segments.” Examples mentioned include education about support programs, deferrals of certain payments and fees, and help in reestablishing credit.

“Unfortunately, in the midst of the crisis, several large U.S. banks have raised credit score and down payment requirements for new mortgages and HELOCs,” says Bancography. “Smaller institutions should seek to compensate for such actions, keeping credit available to all market segments, with proper risk management.”

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