The pandemic caused by the global spread of the coronavirus infection has led to an unprecedented crisis in almost all spheres of life, including the banking sector. According to the Organization for Economic Co-operation and Development (OECD) (2021), “the global recession is expected to be the deepest since the Great Depression with some differences across countries” (p. 9). At the same time, at the beginning of the pandemic, banks could be regarded as a source of relative stability and resilience (Carletti et al., 2020; Giese & Haldane, 2020). In comparison with them, companies and households were more vulnerable to economic challenges due to high leverage. In turn, the banking system had a more stable position due to stronger liquidity and capitalization provided by prior major reforms that had followed the 2007-2009 global financial crisis (Carletti et al., 2020). In addition, central banks were obliged to support governmental schemes and provide loan facilities and emergency funding loans for stand-by liquidity. However, with the rise of the pandemic-related uncertainty and household and corporate indebtedness, the risks to the banking sector were increasing as well.
In the United Kingdom, the bank of England introduced measures of governmental support to protect businesses and people from the economic consequences of COVID-19. Therefore, in 2020, it cut its official interest rate to 0.1% to guarantee cheaper loans for households and businesses (Bank of England, 2021). However, this practice of central banks puts considerable pressure on the net interest margins (NIMs) of commercial banks. While the central bank aggressively cut its interest rate, focusing on funding companies and people, reducing their financial burden, in a long-term perspective, this may impact banks’ profitability and resilience. In addition, low interest rates traditionally reduce banks’ profitability in mature markets (“COVID-19: Impact on the banking sector,” 2020). In this case, financial institutions are forced to limit their earnings by commission-based income.
Those banks that had already experienced low profitability and valuations and nonperforming assets’ high levels are particularly vulnerable to pandemic-related challenges. For the United Kingdom, the situation was more complicated than for other European countries. First of all, it was the most affected state by the coronavirus in Europe, with the worst decline in GDP by 20.4% in the European Union (Baquero, 2020). In addition, the banking system faced the challenges of both Brexit and COVID-19, with major banks demonstrating a decline of 15% in their net operating income in 2020 (Baquero, 2020). However, while the revenues of investment and corporate banks were supported by substantial volumes in the commodities and currencies markets that guaranteed a fixed income, retail and local banks that operated in the domestic market without diversified portfolios were affected more than others. The combination of an extremely low interest rate established by the bank of England and its asset purchase program led to their NIM’s reduction.
As the pandemic had impacted the majority of areas of human activity, a considerable number of people faced unemployment or a cut in salaries. As the financial strength of borrowers decreased in this way, the majority of banking institutions were impacted by other challenges – operational losses and the increased cost of risk. As a result, banking facilities were forced to review their strategic approaches, risk profiles, and operation models, and the achievement of an acceptable return on equity became a critical issue for banks without capital buffers (Garbutt, 2021). At the same time, the banking sector of the United Kingdom had to balance between its financial losses and the ability to provide loans and debt-moratoria in order to support the country’s financial stability. Loans associated with more risks to default affected banks’ provisioning reducing their capability to offer credit. Since the outbreak of the coronavirus, the banking sector had been forced to decline its credit delivery to economic sectors. Construction, industry, agriculture, investment, and working capital credits remain the most affected ones, while trade and consumption credits are supported.
COVID-19-related economic challenges are associated with uncertainty in borrowers’ final financial obligations and substantial risks for the banking sector. In the United Kingdom, banks’ cost of risk increased leading to “the widening gap between the net operating income and the net income” (Baquero, 2020, para. 7). At the end of 2019, the cost of risk was 2 billion pounds, while at the beginning of 2020, it went to almost 8 billion pounds (Baquero, 2020). Retail banks with the main activity in the territory of the United Kingdom were particularly impacted by this increase.
The pandemic-related regulations connected with multiple limitations have affected the performance of the banking sector as well. First of all, all banking systems had to adapt to new realities, including new safety measures, remote work, and electronic services, in an extremely short period of time. While remote work led to greater workspace rotation and a more distributed workforce, banking facilities nevertheless faced the necessity to establish the balance between face-to-face and digital service delivery options (Garbutt, 2021). At the same time, as the COVID-19 lockdown substantially reduced people’s physical mobility, the banking sector had to consider the development and optimization of digital services for both customers and employees. Digitalization in the banking sector led to financial services’ increased contestability on the basis of the prevailing market structure and the transition of banking “from the traditional oligopoly to a system with a few dominant platforms that control access to a fragmented customer base, with a few BigTech firms and some platform-transformed incumbents monopolising the interface with customers” (Carletti et al., 2020, para. 5). For the management of operations and the maximization of data assets, new organizational tools and technology solutions became essential.
The implementation of new IT technologies for quality and time-sensitive banking service delivery that affected customer satisfaction was connected with not only additional regulations and hard work but substantial investments as well. In this case, medium-sized and new banks faced considerable challenges associated with their inability to manage IT investments and expenditures necessary for performance in the COVID-19 environment. Even consolidation was limited by pandemic-related obstacles as countries became more concerned about the safety of their banking sectors.
In March 2020, the Bank of England published its financial policy summary record (FPSR) dedicated to the risks of the financial stability associated with the COVID-19-related economic disruption. According to the FPSR, all major banks of the United Kingdom were ready to withstand economic disruption. In addition, in partnership with HM Treasury and the Financial Conduct Authority, the Bank of England issued a joint letter to banks – in it, authorities expressed “their appreciation of the action already taken” and highlighted the significance of responsive measures’ implementation (“COVID-19: Response from the Bank of England and Prudential Regulation Authority,” 2021, para. 4). Subsequently, in a joint statement, the Bank of England and major banks aimed to assure the public that they had enough resources and capacities to provide support for companies and households across the country. According to Sir Jon Cunliffe, Deputy Governor for Financial Stability, the banking sector of the United Kingdom is resilient enough to cope with the economic challenges associated with the pandemic (“COVID-19: Response from the Bank of England and Prudential Regulation Authority,” 2021). Thus, the most efficient measures should include a particular focus on liquidity buffers and capital usability.
There are several measures introduced by the Bank of England in order to strengthen the stability of the country’s banking sector. As previously mentioned, in 2020, it cut its official interest rate to 0.1% to guarantee cheaper loans for households and businesses (Bank of England, 2021). Moreover, the Bank of England offered banks long-term funding at its interest rate of 0.1% or close to it to increase their lending to companies, firms, and enterprises (Bank of England, 2021). In general, the bank of England undertook all efforts to reduce banks’ financial burden and facilitate their operations. For instance, the 2020 stress test for several major banks in the United Kingdom was canceled to help them focus on the provision of credit to meet the needs of companies and households (“Bank of England announces supervisory and prudential policy measures to address the challenges of Covid-19,” 2020). In addition, the Prudential Regulation Committee and the Financial Policy Committee reduced the countercyclical buffer rate of banks’ exposures to 0% to support the country’s economy in challenging times. Moreover, in order to expand lending, banks’ capital was reduced by the Bank of England. However, in 2020, banks were allowed to cancel dividend payments to their shareholders to keep stability.
On the one hand, the Bank of England expects to boost competition by encouraging new entrants to join the banking sector of the United Kingdom by ensuring its stability, resilience, and responsiveness to COVID-19 challenges. On the other hand, regulatory capital requirements that aim to guarantee banks’ stability and the reduction of risks have a negative impact on their competitiveness. In addition, measures introduced to support the country’s largest banks limit the capacities of small local retail banks (Baquero, 2020). While investment and corporate banks are supported by the Bank of England with more funding in response to the increased lending to small and medium-sized enterprises, the combination of a low interest rate and the Bank of England’s asset purchase program led to the reduction of NIM of small banks that did not have diversified portfolios and substantial resources for resilience and competitiveness within the framework of a severe economic crisis.
Thus, for major banks, the measures introduced by the Bank of England provide a stable basis for recovery and potential development in the competitive environment. A low interest rate stimulates companies and households to lend and spend more money. As a result, the banking sector aims to fill a credit gap by providing greater loan facilities to consumers. However, banks should balance between customer support and the increase of nonperforming loans resulting from the COVID-19-related crisis. In this case, those banks who have government support will be able to compensate for their potential capital depletion in contrast with new or small-sized banks with fewer resources and capacities. At the same time, introduced measures will lead to changes in structures or new opportunities depending on institutions’ potential. For instance, small and medium-sized banks may consolidate in order to survive and remain competitive. In turn, large and more stable banking institutions may acquire discounted companies to expand their product lines on the basis of acquired technology assets.
In turn, those banks that remained should focus on customer service, the use of appropriate channels, new relevant products, the adaptation to new working conditions, and the review of organizational structures and working processes. All in all, responsive measures introduced by the bank of England aimed to support the financial well-being of companies, enterprises, and households in the first instance. As this support was realized through major banks, they received certain benefits as well that helped strengthen their resilience. However, these measures were introduced to keep stability rather than provide enough opportunities for competition in the banking sector. In addition, during the COVID-19-related crisis that was especially complicated in the United Kingdom by Brexit, the entrance of new players with less substantial capabilities in the financial market will be extremely challenging.
For those banks that will stay, low interest rate will provide additional pressure on their profitability, limiting competitive potential. At the same time, banks may compete with each other for customer loyalty through digitalization and the introduction of more services and products. For instance, competitive banks will invest in the development of internet banking due to its efficiency, comfort of use, and opportunity to exclude physical contacts undesired during the pandemic.
In turn, the pandemic and its consequences may lead to the occurrence of new players in the banking sector from other areas. For instance, banks may be involved in the competition with financial technology, IT, and retail companies, such as Google, Alibaba, Amazon, or Apple. As these corporations have already benefited from the pandemic and strengthened their positions, they may want to expand their service provision in the financial sphere as well putting pressure on banks’ business lines.
References
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Bank of England. (2021). Our response to coronavirus (Covid). Web.
Baquero, L. (2020). United Kingdom: Banks face the double challenge of Covid-19 and Brexit. BNP Paribas. Web.
Carletti, E., Claessens, S., Fatás, A., & Vives, X. (2020). The bank business model in the post-Covid-19 world. Vox. Web.
COVID-19: Impact on the banking sector. (2020). Web.
COVID-19: Response from the Bank of England and Prudential Regulation Authority. (2021). Web.
Garbutt, P. (2021). UK banking sector: Top ten themes for 2021 and beyond. GrantThornton. Web.
Giese, J., & Haldane, A. (2020). COVID-19 and the financial system: a tale of two crises.Oxford Review of Economic Policy, 1-15. Web.
OECD. (2021). The COVID-19 crisis and banking system resilience: Simulation of losses on nonperforming loans and policy implications. OECD Paris.