During the COVID-19 pandemic, we found smaller banks expected the peak of distress to hit them later in the economic cycle. Many CROs were also concerned about the fragility of the retail book. This reflects high inflation and the cost-of-living squeeze having increased the pressure on consumers, who are also no longer protected by furlough.
Some takeaways from our research that will shape CROs’ agenda in the short and medium term, include:
Continued use of overlays will require more detailed explanation
Banks enhanced their models post the financial crisis, and implemented International Financial Reporting Standard (IFRS) 9. But they have had to use judgement and overlays in their provisioning when dealing with the impact of the COVID-19 pandemic and the war in Ukraine. They did this well but this is a significant change and challenge for banks and regulators. Models were seen as allowing greater accuracy of forecasting, at a much more granular level, across a range of scenarios. Given overlays are likely to stay for a period of time, banks will need to explain what they represent and how they have been calculated.
Managing constant disruption will continue for CROs
Bank CROs will continue to face an uncertain macro environment. As well as the trilemma risks, they will need to plan for possible new variants of COVID-19, and consider any government measures to support consumers dealing with increased inflation. Judgment will continue to be critical in how banks navigate all these interacting forces in the months and years ahead.
Cautious approach to be welcomed
Post 2008, it was agreed banks should hold more capital and book provisions earlier. While the last few months have shown the limitations of modeling in achieving that, CROs have used their judgment to add more caution and resilience in the system. The use of overlays and provisions is much more helpful than the alternative of booking defaults and incurred losses when they arise.
Increased stresses could materialize at some point
So far, the banking system has avoided major problems. However, outstanding debt from COVID-19 loans, combined with the trilemma risks (money, energy and supply), means banks may be facing significant credit impacts in the medium-term. Bank CROs recognize that there is more downside risk at present.
This article is co-authored by EY's Laure Guégan, EMEIA Financial Services IFRS Leader and Erberto Viazzo, EY EMEIA Financial Services NPE Leader; Partner, Strategy and Transactions, EY Advisory S.p.A.