15 minute read 18 Sep 2020
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COVID-19: How Asia-Pacific can lead the way in lending transformation

By Andrew Gilder

EY Asia-Pacific Banking and Capital Markets Sector Leader and Ernst & Young LLP Assurance Partner

Banking and Capital Markets Leader. Over 20 years of experience in the field of auditing.

15 minute read 18 Sep 2020

The COVID-19 pandemic has overturned credit markets across the world. How banks act in 2020 could shape their performance for years to come.

Three questions to ask
  • Is the global pandemic a catalyst or a barrier to smarter lending?
  • How will the banks’ business models be revolutionized by the current crisis? 
  • How will strategic collaboration change the future of Asia Pacific’s credit markets?

For banks, the sudden downturn and economic strains are reminiscent of 2008. But this time, the industry, its solvency and liquidity boosted by post-crisis reforms, is not the source of the problem. Instead, it’s a critical element of the solution.

This is creating the most important moment for Asia-Pacific’s banks in decades. Governments, regulators, investors and borrowers are looking to the industry for resilience and leadership. Risks are heightened, and so are opportunities. How banks act in 2020 and 2021 will not only define their response to the crisis, but also  shape their performance for years to come.

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Chapter 1

COVID-19 pandemic is a financial super disruptor

The pandemic is pushing markets in the Asia-Pacific region into their first recession for decades.

The COVID-19 pandemic may be a health crisis, but it has also shredded economic assumptions. It’s pushing major markets such as Australia, Japan and Singapore into recession and reducing growth in others to a near standstill. Governments, central banks and supervisors have leaped into counter-cyclical mode. Authorities across Asia-Pacific have cut interest rates, boosted money supplies, guaranteed loans, issued grants, deferred taxes, eased capital requirements and encouraged forbearance.  

The region’s commercial banks have become the emergency workers of these economic relief programs, delivering financial aid to those most in need: small and medium enterprises (SMEs), individuals, and under-pressure corporates in sectors like travel, hospitality, retail and commodities. They have moved fast to transmit stimuli and support customers: handling a surge in enquiries, waiving fees, arranging payment holidays and processing unprecedented volumes of credit applications, often using rapidly installed technology. Achievements are made more impressive by the practical hurdles banks have had to overcome: closing branches, switching to home working, relocating trading floors and maintaining continuity.

Even so, the crisis continues to pose huge operational challenges for banks. Mobile and online capabilities are often insufficient to meet demand. Staff can struggle to access core systems remotely. Many key workflows are antiquated, with over-reliance on paper and manual processes. Failures by offshore and outsourced support centers point to a need for closer control of customer experiences. Remote working is exposing banks to cyber attacks, and there are signs of increasing customer fraud as financial pressures bite.

Furthermore, Asia-Pacific banks face exceptional financial challenges. Big banks’ balance sheets have built significant capital strength in recent years, and deposit inflows during the crisis have helped to offset the liquidity impact of loan drawdowns. Even so, the sudden shift from a long period of lending growth to an economic contraction will create significant strain. Asset quality is already falling. In Australia, first half impairment charges for the four majors totaled AUD5.7b (US$3.9b). But the full picture will only emerge when fiscal support is unwound and repayment moratoria come to an end. Loan losses are expected to extend over several years, with one recent study forecasting that Asia-Pacific banks will account for about 60% of credit losses globally during 2020 and 2021.1

In response, banks are working flat out to monitor portfolios and calibrate their provisions under IFRS 9 – although in some markets such as South Korea, regulators have issued temporary guidance on how this should be applied. The coming months and years will require banks to manage growing distressed debts and conserve their capital. Many will need to trim financial investments, begin or accelerate the divestiture of non-core assets, and limit distributions. The downturn may also trigger an acceleration in business failures especially, but not only, in the SME sphere. On top of these challenges, the underlying pressures on profitability that predate the crisis – such as low interest rates and compliance costs – have not gone away.

The effects of this crisis are only beginning. It promises to be a marathon, not a sprint.

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Chapter 2

2020: a pivotal moment for banking models?

The economic downturn makes it important for banks to address the pre-crisis imperatives of resilience, efficiency and customer-centricity.

The pandemic is forcing Asia-Pacific banks to confront the weaknesses of their current operating models. The economic downturn also makes it even more important for banks to address the pre-crisis imperatives of resilience, efficiency and customer-centricity.

The good news is that the first half of 2020 has seen customer behavior change faster than any point in living memory. Cash usage and face-to-face contact has fallen; contactless payments and digital adoption have leaped. In Hong Kong for example, the use of digital tools in retail banking jumped from 40% to 80% in the space of a few weeks.2 The more advanced banks will be hoping that many of these changes can be made permanent, given the potential for automated, digitized processes to reduce manual interventions and lower ongoing operating costs. In contrast, less sophisticated banks will find themselves playing digital catch up.

Many institutions in the banking industry have also found they can implement change far faster than they thought. For instance, MUFG has acted fast to streamline SME loan applications, while DBS has launched a new contactless payment card for logistics companies.3 Set against that, banks that have barely begun digitization look increasingly disadvantaged.

The upshot is that many Asia-Pacific banks are eager to use the changes in recent months as a springboard for further improvements in efficiency, responsiveness and accessibility. It looks increasingly likely that 2020 will be a catalytic moment in the transformation of banks’ business models. The scope of change is greatest in the retail and SME space, but there is clear potential to adapt traditional relationship management and enhance remote delivery in corporate banking too.

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Chapter 3

The crisis will accelerate the shift to "smarter lending"

Banking models need to evolve in various ways if they are to rise to the challenge in this unprecedented moment.

So how do banking models need to evolve if they’re to rise to the challenges of this unique moment?

1.  Accelerate technology transformation

Most obviously, technology transformation will need to accelerate. To date, banks’ progress in embracing the fourth industrial revolution has varied widely across Asia-Pacific. A large Chinese bank, for example, is more likely to be at the cutting edge of digitization than a regional Japanese lender. Now, however, transformation has become an urgent priority for every bank. Key priorities include:

  • Using robotics to automate high volume processes such as retail lending applications, helping to reduce reliance on manual work and conventional outsourcing.
  • Increasing the use of cloud computing and remote access to core banking systems
  • Accelerating the digitization of interactions, products and services. This includes reducing face-to-face contact in branches, and corporate relationship management.
  • Applying AI and machine learning to data analytics and information processing across a range of lending functions.

Whether banks develop new tools in-house, in partnership with vendors or on a managed service basis, experience suggests that alignment with existing systems, local customs and banking regulation will be crucial to realizing the full potential of transformation.

2.  Increase the use and value of data

Increasing digitization and automation will drive a fresh explosion in the use and value of data. Within the privacy laws of different markets, banks will need to work to match their own customer insights with BigTech levels of data analysis. Establishing a single, authoritative “source of truth” for product, financial and customer data will be a priority for many.

Data analysis will support a growing range of banking activities, ranging from talent management to cyber defense to strategic thinking. But lending will be the most important area of focus, with algorithms and AI analyzing huge data volumes and triaging credit decisions.

Banks will also use new, different data types suited to a post COVID-19 pandemic world. Customer data will become richer and more forward looking, covering financial status, collateral values, risk weightings and sector-specific indicators. In the retail and SME space this will be complemented by behavioral data. In the corporate arena, application programming interfaces could provide real-time access to clients’ financial systems, allowing banks to offer intelligently priced credit.

3.  Forge a new approach of talent management

These changes will be matched by an evolution in talent management. Most obviously, the skills that banks need will change. First, the credit downturn will force banks to reprioritize credit underwriting and bad debt work-out skills. Second, technology transformation will accelerate demand for engineers, designers as well as cloud and cyber specialists. Changing business models will also require enhanced capabilities in areas as diverse as data interpretation, critical thinking, geo-politics, strategy and stakeholder communication.

But skills requirements are only half the story. The way that banks manage talent will need to change too. The pressures of the crisis have highlighted the importance of well-being and the value of emotional intelligence. The need to broaden skills sets without increasing headcount will also encourage more nimble and adaptable approaches to recruitment, retention, training and reward.

4.  Transform business models

Taken together, these incremental changes will have a transformative effect. This is about much more than responding to a downturn or avoiding a return to the costly, labor-intensive processes of old. The coming years will see the entire lending lifecycle become far more efficient, intelligent and flexible. New business models are likely to include:

  • Developing new risk management and stress testing techniques, using real time information to monitor and reprice risk throughout the credit lifecycle, and allowing banks to pro-actively manage their exposures to different sectors. Making smarter use of balance sheets, and reviewing risk weightings and capital allocation more dynamically than in the past. This includes reacting to evolving government policies, and making selective use of “originate to distribute” models by selling off loans to third parties while retaining control over key customer relationships.
  • Increasing distribution of infrastructure and governance – although the experience of recent months suggests that banks in markets such as Japan and Korea may opt to retain a higher degree of centralization than in others like Hong Kong or Singapore.
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Chapter 4

Innovation must go hand-in-hand with strategy and sensitivity

The success of banks’ responses to the crisis will depend on their ability to navigate conflicting expectations.

It’s not only banks’ business models that will be revolutionized by the current crisis. The industry’s strategic dynamics are shifting dramatically too.

Most obviously, the vital economic role that the sector is playing provides a unique opportunity for banks to prove their social value. Amid a global pandemic, banks are providing essential banking and payments services, channeling government support to businesses and households, and using their own balance sheets to provide much-needed credit. These actions are helping the industry to build customer trust and public esteem.

Equally importantly, the downturn is forcing banks to review their sector exposures. Capital allocations always shift during a crisis, and many lenders see this as an obvious moment to pivot away from less attractive markets and customer segments.

However, the decisions banks take now will be scrutinized as never before. Investors and regulators are watching their conduct closely. Banks need to avoid making hasty reactions to volatile markets, and ensure that lending, provisioning and strategic decisions are made based on sound fundamentals. The withdrawal of government support programs is likely to represent a particularly sensitive moment. Banks also need to re-examine traditional credit workout processes and outsourced collections, ensuring that distressed borrowers are treated in line with today’s societal norms. 

In other words, the success of banks’ responses to the crisis will depend on their ability to navigate conflicting expectations. At a minimum, they need to defend their capital and shareholders while providing appropriate support to borrowers. But lenders also face ill-defined social expectations from governments and citizens, at a time when falling credit quality is encouraging more selective lending. Banks have a tricky balance to strike between credit risk and conduct risk, and between the competing demands of different customer groups.

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Chapter 5

The view from 2030

The choices that banks made in 2020 are the start of a major shake-up in the structure of Asia-Pacific banking.

There are already signs that competitive dynamics are shifting. Large-cap banks are enjoying a “flight to quality” by consumers, leveraging their scale, brands, capital strength and through-the-cycle experience. In contrast, their digital-only rivals face increasing headwinds, illustrated by the May 2020 cancellation of one Australian IPO.4  

But this does not mean that the coming decade will simply see Asia-Pacific’s leading banks reassert their traditional dominance. Online-only rivals such as KakaoBank of Korea, and the regional expansion of some of China’s BigTechs like Ant Group – currently awaiting a license in Singapore – are not going away.

It’s more likely that the shape of the region’s credit industry will be determined by comparative advantages. The region’s biggest banks have major strengths, but many are burdened with excessive costs and outdated infrastructures. FinTechs and neobanks boast agility and speed but need more capital to grow. Second tier banks have local knowledge, but limited scope to invest in digitization. BigTechs have an edge in data analysis and user experiences, but limited lending experience.

These contrasting strengths and weaknesses suggest that relationships will be as important as rivalry in shaping the development of Asia-Pacific’s credit markets. Some key developments could include:

  • Consolidation among second tier lenders, leading to the emergence of fewer, stronger and more specialized competitors for the biggest banks.
  • Deeper alliances between banks, software vendors and cloud providers. The biggest banks will continue to acquire smaller FinTechs, but smaller lenders will also increase their partnering with technology firms – something that Japanese authorities have said they would welcome.5
  • Broadening the use of strategic partnerships to enhance distribution and offer seamless digital services. MUFG’s recent investment in Singapore’s super-app Grab6 provides an illustration.
  • Start-ups and online only banks leveraging their agility (and the Open Banking reforms in markets such as Australia and Singapore) to expand their spectrum of retail and SME services.
  • BigTech and e-commerce giants building on their existing payments capabilities to develop their lending services, especially to retail customers and SMEs in their supply chain, about whom they have rich behavioral data.
  • A progressive insourcing and onshoring of the end-to-end credit lifecycle.

Whatever the future holds for individual institutions, Asia-Pacific’s high levels of digital adoption and economic diversity could put it at the leading edge of the future evolution in global lending.

  • Selected actions by central banks & monetary authorities

    People’s Bank of China
    • Provided banks with an additional CNY300b (US$42b) in funding for SME loans and CNY100b (US$14b) for agricultural loans via re-lending quotas.
    • Reduced the required reserve ratio for banks three times in the first five months of 2020, releasing CNY1.75t (US$248b) of funds to support banking system liquidity and enhance support for MSMEs.
    Hong Kong Monetary Authority
    • Launched with HKMC Insurance Limited the Special 100% Loan Guarantee under the SME Financing Guarantee Scheme.
    • Lowered the regulatory reserve requirement for locally incorporated authorized institutions by 50%.
    Bank of Japan
    • Introduced a JPY110t (US$1t) program to facilitate corporate financing, including increased purchases of corporate bonds and commercial paper, and funding measures to encourage lending by financial institutions.
    • Announced no upper limit on its purchase of Japanese government bonds with an aim to maintaining stability in the bond market and stabilizing the yield curve at a low level.
    Monetary Authority of Singapore
    • Announced a US$60b swap facility with the US Federal Reserve to provide US dollar liquidity to financial institutions in Singapore.
    • Launched the MAS SGD Facility for ESG Loans in partnership with Enterprise Singapore, to lend Singapore dollars at an interest rate of 0.1% to eligible financial institutions to support their lending to SMEs under the ESG Loan Schemes.
  • Selected actions by commercial banks

    Australia
    • In response to the government’s SME Guarantee Scheme, banks have launched specific, low-cost loan products with discounted interest rates and benefits such as no establishment fee and no repayments for six months.
    Mainland China
    • Banks are reported to have issued special purpose certificates of deposit offering low cost funds for companies engaged in COVID-19 pandemic support efforts.
    Hong Kong
    • HSBC announced US$4b in additional liquidity relief for Hong Kong businesses, aimed at easing businesses’ cash flow pressure and helping them respond to challenges from market uncertainties and supply chain disruptions.
     Japan
    • MUFG was reported to be issuing Japan’s first “coronavirus bond” to help finance SMEs, targeting investors who focused on ESG factors in their investment management.
    Singapore
    • DBS announced a digital package to help Singapore’s food and beverage industry, working with two local start-ups to offer businesses the ability to set up an online food ordering site in three business days to create new income streams.
    South Korea
    • Shinhan Bank signed a memorandum of understanding with the Korea Trade Insurance Corporation to offer financial support to foreign subsidiaries of SMEs facing COVID-19 pandemic challenges.

Summary

As an unprecedented source of disruption, COVID-19 presents banks unique possibilities for strategic change and business model transformation. The priority now is to address weaknesses, build on successes to date and accelerate transformation for the future.

Asia-Pacific has been at the leading edge throughout the pandemic, and the rest of the world will be watching closely to see how its banks respond, recover and reorganize. Banks that can strike the right balance between stability and growth, and between the competing interests of different stakeholders, could help to redefine the future of the industry.

About this article

By Andrew Gilder

EY Asia-Pacific Banking and Capital Markets Sector Leader and Ernst & Young LLP Assurance Partner

Banking and Capital Markets Leader. Over 20 years of experience in the field of auditing.