How to Measure and Fund Challenged Assets for Better Balance Sheet Management

Peter Eisenhardt
Secretary General, International Council of Securities Associations

The response to COVID-19 by governments and central banks has been dramatic. Extraordinary balance sheet management approaches - including rate cuts, asset purchase programs, loan programs, guarantees, and direct aid payments - have ensured the economy and banks have endured. While fiscal consequences may be felt for years to come, the official sector has taken bold steps in an unprecedented situation where large economic segments have shut down

Banks, regulators, and central banks can take encouragement from the fact that the job of stabilising banks has been made easier with more robust balance sheet management going into this crisis compared to the last.

Measures enacted after the 2007-2008 global financial crisis have ensured that banks have doubled and even tripled their capital and liquidity buffers.

While central banks can stand ready and firm as lenders of last resort, they cannot insulate banks from inevitable credit losses, impacting balance sheet management.  While share prices in many sectors have rebounded sharply, banks’ shares are still depressed. Besides the credit hits, banks need to cope with compressed lending margins in the lower rate environment.

Establishing the size of credit losses for better balance sheet management will be a tremendous ongoing challenge.  No one can predict when the pandemic will end and whether there will be a second wave. It’s not clear when social distancing will be relaxed so that work and activities can resume, and how various sectors and supply chains will adapt. Estimates of credit losses are wide-ranging, from anywhere between $400 billion and $1 trillion.

Banks’ calculation of losses will be further complicated by i) flexible accounting standards introduced by prudential authorities, ii) various public and private debt relief and guarantee programmes, and iii) repayment holidays.

Funding requirements will be somewhat eased by restrictions on the payment of dividends and share buybacks.

From now on, banks will need to make hard decisions in their balance sheet management in order to determine which challenged assets will continue to be funded and which will be written off as charges to capital. The right technology can help.

With Oracle Financial Services, customers can accurately model the detailed and complex events on the balance sheet for both the current book of business and forecasted new volumes. Our unified, integrated set of solutions for Funds Transfer Pricing, Asset Liability Management, Balance Sheet Planning, and Profitability all share the same underlying data model to deliver accurate margin forecasts and comprehensive, meaningful budgets.

To learn more, feel free to message me to explore more or have a conversation.

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