Recent events have reminded us how rapidly the world and business outlooks can change. Just as important, our current reality also underscores exactly how critical insight and agility can be for financial institutions and their corporate customers who need the right capital clarity to successfully navigate the unexpected.
The Impact Across Industries
In the last month, we’ve experienced three important developments that will challenge financial institutions and their corporate customers in the coming year.
- Corrections in equity markets: We’ve witnessed extreme volatility and huge corrections in equities markets across the globe. The U.S. entered a Bear market for the first time since the 2007-2009 recession. Also, in the course of one week in March, we experienced the best and worst day in U.S. market history. The global correction spans nearly all sectors, but is hitting some harder than others. With oil at decades-low prices, the energy industry has been hard hit, as has the aerospace and defense sector with air travel demand slowing to a crawl. Mining and travel and leisure categories are also under disproportionate stress.
- Increased exposure risk / default risk: It follows logically, that, as valuations fall, these same industries—which are largely asset intensive—will have significant exposure around their future cash flows, at least in the short term. This drives up risk for corporates and their financial services partners.
- Higher insurance premiums for banks: As the risk of default rises in today’s environment, so do costs for banks as they now face higher insurance premiums relative to credit default swaps. Banks are paying higher insurance premiums for industries under stress, including oil and gas, aviation/transportation, tourism/leisure, and manufacturing.
Re-Thinking and Re-Examining: A New Paradigm for Corporates
In this environment, corporates can and must take decisive actions that can help mitigate the short- and longer-term risk. The key to success is the ability to gather accurate data, analyze thoroughly (predictive and historical), and move forward quickly to gain capital clarity. Corporates need to:
- Secure and re-think the supply chain: The global supply chain is under duress. Manufacturing has paused or dramatically dropped; transportation and logistics has slowed to a crawl; and workers are adapting to a new normal as they work remotely. According to United Nations economists, global exports fell by $50 billion in February, alone. In this unprecedented environment, corporates must re-examine their supply chain plan for immediate agility potential. As important, they must create a new framework around how they will adapt longer term to mitigate the impact of a future Black Swan event.
- Ensure availability of approved lines of credit: Corporates need to communicate with their banking partners to make sure that lines of credit that were approved a few months ago are still viable and available at the same terms—without the need for additional collateral, which a corporate may now not be in a position to provide to the bank. So, it’s important from a CFO’s perspective to know whether a corporate’s banks are truly on board─in essence gaining a better picture of overall capital clarity.
- Re-examine all credit terms: We expect to see the industry moving rapidly in the short term to a preferred cash-only model—I sell the goods, I get the cash, or I get the cash and then ship the goods. Right now, liquidity (aka, cash) is king, and credit terms are increasingly stringent. Large corporates need to ensure that the credit terms they have with their suppliers are built in a way that does not fold the business. At the same time, corporates might be pressed to extend the terms that they have with their dealers/distributors. Therefore, it is essential to review credit terms from all angles during this volatile time.
- Revisit capital investment plans: In today’s environment, it’s all about conserving cash. As such, corporates need to aggressively re-evaluate, prioritize and/or place on hold all their investment and market expansion plans. Given the stress in the system, this gives companies with strong balance sheets a great opportunity to buy capabilities at very good valuations.
- Shift away from fixed costs for added liquidity: Corporates should look for new opportunities to reduce their fixed costs, including moving them to a variable model, such as outsourcing non-core activities.
- Improve cash flow by extending payables and expediting receivables: Corporates need to look at extending payables intelligently. To do this, they must take a holistic approach and consider both the distribution function as well as the supplier function. At the same time, they needed to take steps to identify and act on opportunities to accelerate and better manage their receivables for improved cash flow.
- Tighten inventory management: This must be a top priority. Corporates need to re-think how they can avoid the cost and burden of excess inventory, especially at this time. In some cases, manufacturers are finding themselves already saddled with inventory produced for seasonal events—items that may no longer be needed to the extent originally planned. Businesses must think creatively about how to reduce this inventory today and re-structure their processes to ensure greater agility moving forward.
- Explore alternate supply chain financing: Corporates must speak with their banking partners and understand the options available to them under supplier or dealer financing programs.
The bottom line is: corporates, at this time, need to focus on liquidity. As they work toward this critical goal in the coming months, they also—with proper insight and definitive action—can position themselves for a faster recovery, long-term stability and profitability.
What should banks expect?
Banks are similarly at risk as their corporate customers begin to struggle and adapt. We expect to see three immediate impacts:
- Higher default risks: There’s significant risk on credit in the wake of the Covid-19 crisis. This may result in a very high rate of default across industries and put the credit portfolio for banks at great risk.
- Pressures on net interest income: Net interest margin will decrease as rates remain low and may continue to fall. Any increase in borrowing volumes, for example from drawdowns on lines of credit, may be offset by losses in credit portfolios. In addition, the central bank is asking financial institutions to re-price loans and the Federal government is telling banks to be lenient about interest repayment. There may even be a time where banks will be asked to forgo interest for the next six months.
- Pressures on fee income: In the short term, banks will face pressure around fee income driven by a slowdown in global trade and stress on cash management services. However, it will be the fee-based services that will ultimately take banks out of this current state. Banks that have invested prudently around generating significant fee income will be better positioned in the near future than banks that have relied primarily on credit as their revenue earnest. This is the time to start investing in the fee side of the business—which is the foundation of transaction banking.
To summarize, this time of uncertainty underscores the need for a new way forward, built on the foundation of capital clarity—from both banks and corporates.
As financial institutions take immediate action to stem the impact of the current downturn, they have a golden opportunity to build deep and lasting client relationships. Secondly, this crisis also gives them a chance to reflect and ask fundamental questions, such as “what intelligence and insight is needed in terms of risk, profitability, and liquidity for each customer and enterprise?” and “what systems are needed to mitigate the impact of the next unexpected event?”
To learn more, feel free to message me to explore more, or have a conversation.
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Oracle Corporate Banking Solutions: oracle.com/corporatebanking
Oracle Financial Services: oracle.com/financial-services
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