Financial institutions are showing resilience and will be central to the recovery

A year ago, more than 120 countries were in the midst of full or partial lockdowns, hoping to limit the spread of COVID-19. Since then, the seesaw between easing and tightening restrictions on mobility and economic activity has become all too familiar as the world seeks to balance the health toll and economic impacts of the crisis. Today, vaccinations are finally being rolled out across many countries, but the tragic record numbers of infections registered in India and other emerging markets in recent weeks remind us that the virus is far from defeated.  

While this crisis did not originate in the financial sector, the sector was deeply impacted. Mobility restrictions and reduced economic activity exposed financial institutions to extraordinary operational and financial challenges. Banks across most of the countries where IFC operates were also asked to play an active role in the crisis response—by adhering to government moratoria on loan repayments and extensively restructuring their portfolios.   

In October, IFC launched a survey The Early Impact of COVID-19 on Financial Institutions to systematically assess the early impacts of the pandemic on our client financial institutions. We asked them how the crisis affected their operations, funding positions, and portfolios. And we asked about their outlook and the strategic directions they expect to make.  

The survey confirmed that, despite the profound blow inflicted by lockdowns and the drop in economic activity, a liquidity crisis has thus far been prevented. However, government moratoria and other crisis-response policy measures have masked non-performing assets, suggesting that credit risks are lurking on the horizon. As a result, governments and development finance institutions should support the solvency and digital transformation of the financial sector, enabling it to play a central role in the economic recovery.  

The survey found that:  

• Operations were impacted, but liquidity has held thus far
  More than six months from the peak lockdown months that led many of our clients to close offices and branches for several weeks, eight out of 10 financial institutions reported operational levels well below their pre-crisis levels. Loan collections were similarly affected. Yet, despite initial concerns spurred by the high degree of volatility and uncertainty, more than nine in 10 financial institutions managed to preserve their liquidity positions as a result of strong performance of deposits, adequate provisions, and access to emergency liquidity from central banks and investors. IFC’s fast-track response has committed nearly $4 billion in working capital and trade financing to date.  
   
• Digital transformation went from being a priority to an urgent necessity
  Learning to operate and interact with customers remotely became a matter of business continuity for all of us during the crisis. While digital transformation was already a corporate priority for most financial institutions, the survey clearly shows how the pandemic increased the urgency for ambitious digital transformation efforts. More than one in two clients indicated that investments in digital channels, such as mobile and Internet banking, as well as in the digitization of back-end processes had become of greater priority or urgent. 
   
• Lending slowed down, but this time it is different
  Unlike past crises, including the 2008-2009 Global Financial Crisis, the decline in lending was not due to liquidity “dry ups” in the financial system. While institutions were careful to maintain liquidity, the low levels of new business are likely due to a strong contraction in demand due to the impacts of mobility restrictions on income flows for businesses and households. Debt moratoria and government transfers have likely also contributed to depressed demand for an extended period of time. Going forward, demand—particularly for medium- to long-term financing—is expected to pick up. But the uncertainty of business outlooks and the realization of credit risks following the unwinding of fiscal stimuli and moratoria on loan repayments will challenge the ability and appetite of financial institutions to grow their portfolios, especially for riskier micro, small and medium-sized enterprises (MSMEs). The survey has already shown concerning signals of this flight to quality as retail and MSME lending was deprioritized by 27 percent and 18 percent of financial institutions, respectively. 
   

The survey shows that the pandemic had not (yet) morphed into a liquidity crisis by the end of 2020. While the sector appears to have maintained liquidity in recent months, as the crisis continues to unfold, the risks persist. Avoiding those risks will require action from the public and private sectors. Governments and investors must support solvency of financial institutions and help create the conditions for financial institutions to play a central role in the economic recovery.  This will include direct support by governments and development institutions for balance sheets and management of non-performing assets. Development finance institutions have a key role, particularly in lower-income, fragile and conflict-affected markets, to support investment in technology and help de-risk lending to segments that are central to the economic and social recovery, such as MSMEs, women-owned enterprises, and lower-income households.