The financial system entered the period of the COVID-19 pandemic in a good condition, but the magnitude of the pandemic-related shock is substantial
The COVID-19 pandemic has triggered an unprecedented shock to the real economy and the financial system globally. This highlights how important it is for financial institutions to maintain a high degree of resilience during the entire financial cycle, should unexpected events occur.
Financial Stability Report, June 2020
The Polish financial system entered the period of the COVID-19 pandemic in a good condition, demonstrating resilience to shocks and without substantial imbalances. Both the credit growth and the debt-to-GDP ratio prior to the shock remained moderate and banks’ funding structure was stable and safe. The vast majority of banks more than meet the capital requirements and short-term and long-term liquidity standards.
The pandemic-related shock has highlighted the existing vulnerabilities of the financial system and led to the emergence of new risks. In view of the impact of the COVID-19 pandemic, the following processes need to be closely monitored:
- Credit risk – due to the deterioration in the financial standing of borrowers, the likelihood of materialisation of credit risk in all credit categories has grown substantially, which will negatively affect the level of banks’ provisions and earnings.
- The risk of a credit crunch – high uncertainty over the pandemic’s impact on the condition of banks and borrowers may lead to a credit crunch. Measures taken by public authorities may only partially reduce the risk, but the rate of lending growth will crucially depend on banks’ risk appetite, and on loan demand.
- The importance of links between the banking and government sectors is growing as a result of the increased involvement of the banking sector in Treasury bonds and bonds guaranteed by the State Treasury.
- Individual financially distressed credit institutions – before the outbreak of the pandemic, some entities were financially distressed and had insufficient surpluses of capital. Their problems may have an indirect negative impact on the earnings of other institutions. The extent of the shock points to a greater likelihood of such a scenario.
In the situation associated with the COVID-19 pandemic, the top priority is to maintain lending to the economy and, at the same time, preserve the security and resilience of the financial system. In Narodowy Bank Polski’s view, the implementation of the recommendations listed below will be conducive to achieving this goal.
- Credit institutions, insurance undertakings and investment fund management companies should earmark all the profits of previous years to increase their capital base.
- Banks should develop solutions that facilitate debt servicing for pandemic-affected borrowers, including, among others credit holidays, or allow them – in justified cases – to restructure debt.
- Banks should maintain individual risk assessment and, among others, avoid automatic translation of the assessment of the state of play of specific industries into an assessment of the credit standing of people employed in them and companies active in the industries.
- Banks and audit firms should cooperate to develop a harmonised approach to credit loss reporting.
- Investment fund management companies should take action to reduce liquidity risk in the open-ended investment funds that they manage.