7 minute read 9 Apr 2020
EY Challenger & Specialist banking

How COVID-19 is impacting Challenger & Specialist banks and building societies

By

Ian Cosgrove

EY UK Head of Challenger & Specialist banks

Passionate about helping Challenger & Specialist banks transform the UK banking market. Strategic thinker and relationship builder. Irish rugby fan.

7 minute read 9 Apr 2020

What lies beyond the COVID crisis for the UK’s Challenger & Specialist banks and building societies?

The past few weeks have radically reconfigured the operating environment for Challenger & Specialist banks and building societies across the UK. Major disruption to supply and demand dynamics, the challenges of delivering full services remotely, and the task of managing an unprecedented number of customer enquiries have ramped up the pressure on high-speed decision making for leaders across the sector. What lies beyond the crisis for the UK’s Challenger & Specialist banks and building societies?

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Chapter 1

What we have seen so far

Despite a slump in demand, a diversion of operational capacity, and disruption to third-party supply chains, the sector should be well positioned to weather the storm.

 

Demand slumps

As the government’s lockdown measures have ramped up, we have seen a major slump in demand, with both the residential and buy-to-let mortgage market grinding to a sudden halt. Demand from small and medium-sized enterprises (SMEs), outside of applications for Coronavirus Business Interruption Loan Scheme (CBILS) products, has also waned significantly. Interestingly, we have not yet noticed the increased demand for consumer credit in the specialist segments we expected. However, this is not necessarily an unwelcome development, as operational capacity for new business has so far been diverted elsewhere, and lenders have sought to protect cash and capital.

Operational capacity is being diverted

Operational capacity has been diverted to managing inbound enquiries from customers and requests for forbearance, with a wave of payment holidays and other relief measures being granted. In this area, the sector sought to do the right thing by its customers well ahead of the Financial Conduct Authority’s official guidance through its forbearance actions. While it is too early to draw any definitive conclusions, early indications suggest the extent of relief that lenders have needed to grant is not as significant as initially expected. Much will depend of course on how long the disruption continues.

Capital and liquidity should hold up

The sector, by and large, entered the crisis in a position of capital strength. This, together with the release of the countercyclical capital buffer and other measures, should position it well to weather the storm. When it comes to liquidity, it entered the crisis in a very liquid position, a stark difference to the 2008 financial crisis, and was further helped by the speed of the Bank of England’s response. We have also heard anecdotal reports of net deposit inflows, possibly due to consumers and SMEs managing their Financial Services Compensation Scheme limits, more money being held in cash than invested, and a limited pass-through of the recent reduction in the base rate.

A stark difference to the 2008 financial crisis.

IFRS9 provisions a source for concern

With regards to banks’ provisions, IFRS9 provisions have been a source of concern for Q1 reporting and beyond, with regulators publishing guidelines to help address these worries. It is likely that in the short term, banks will solve this by calculating overlays to ensure their measurements capture different macro and medical scenarios, government support and other impacts.

Disruption to third party supply chains

One area where we have seen clear disruption however, has been in third-party supply chains. Understanding the impact of third-party remote working on data security and potential data leakage, an inability to conduct appropriate third-party risk assessments, and difficulties in obtaining holistic third-party views to spot dependencies and vulnerabilities, rank among the main challenges we have seen in this period.

 

 

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Chapter 2

A sector in transition

Banks’ and building societies’ interaction with their customers has become more digital, while new ways of working have been adopted at scale.

The people impact

Overall, the sector has largely transitioned well to remote working. Call centres and other customer contact capacity held up successfully, while remote board meetings have rapidly become the norm.

Throughout this transition, we have seen new and more frequent forms of communication adopted. Human resource (HR) departments have had their hands full working through the significant implications of this crisis on people. Whether focused on employee wellbeing, remote working protocols or allowing employees to juggle work and home schooling, HR functions have been successfully supporting the new remote working norms.

By necessity, the way the sector interacts with customers has become more digital, which has in turn led to the streamlining and digitalisation of many internal processes and control functions.

Coronavirus Business Interruption Loan Scheme

While the transition to remote working was as smooth as could have been hoped for, implementing CBILS has turned out to be a massive challenge for the industry, highlighting the length of the process and difficulties involved with SMEs getting loans. Some of the key challenges involved the initial accreditation process and perception gaps between what the industry and the SME sector thought the products were designed to offer.

 

 

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Chapter 3

What comes next

Having a clear picture of the future is practically impossible in these still very early days of the COVID-19 crisis, but we’ll look at a few key areas over the coming weeks and months to find out what to expect.

Impairments will be affected

First, as the payment holidays begin to expire, we should begin to see the true underlying impact on impairments. Given the volume of payment holidays extended, there are going to be significant data, process, capacity and conduct challenges to address as lenders work through who is performing, who’s on a watch list, and who is entering arrears management. We could potentially see an extension of these payment holidays. Whilst a downside in of itself, it might usefully allow more time to work through with borrowers what will happen as they come to an end.

IFRS9 challenges take the spotlight

IFRS9 challenges will also take the spotlight again, as interim reporting for many listed businesses in the sector will coincide with current payment holidays’ expiration dates. However, it is still too early to accurately predict the impact of this.

The severity of the situation will largely depend on the expected performance of the economy, which in turn will depend on the Government’s exit strategy. For newer businesses, this crisis represents a very rigorous test of their resilience, and for those that fare well, they will have been able to prove their ‘through the cycle’ resilience.

Beyond the crisis

The UK’s exit strategy will also determine what the resumption in credit demand will look like. Should there be a steep bounce back, significant operational challenges will occur again as lenders will be dealing simultaneously with the back book as well as new lending applications. Should it take longer, SMEs will be operating with more debt to service, which creates different challenges.

With front end operations potentially stressed, the industry will have to face a number of operational questions, including how it can minimise dropouts in applications and maximise new business opportunities. Over the long term, it will also be interesting to watch the behaviour of consumers and SMEs, and whether we’ll see a growing inclination to build up a cash buffer and an increased propensity to save.

The sector’s adoption of technology to further improve customer and colleague experiences will likely be accelerated.

Technological adoption will accelerate

Technological adoption in the sector will also be impacted. Following the more streamlined and digital nature of customer interactions during this period, the sector’s adoption of technology to further improve customer and colleague experiences will likely be accelerated.

Third party risks should be assessed

With complex supply chains impacted simultaneously in volatile market conditions, organisations will also need to deploy greater resources towards identifying and understanding the heightened risks associated across their third parties, and take stock of the broader lessons learned around protecting an organisation’s operational resilience.Impact on the workforce

Strategic workforce planning will be required

The scope and scale of transitions over recent weeks evidences the agility and adaptability of employees across the sector. However, there is no precedent for entire workforces working remotely for an indefinite period of time. As such, the risk of fatigue presents as a very real possibility. But beyond this, there is little doubt that the balance between on-site and remote working has permanently shifted.

We are also anticipating a greater focus on cost and workforce optimisation – a delicate balance between ‘doing the right thing for employees’ versus the need to adopt new technologies and reduce cost.

We are anticipating a greater focus on cost and workforce optimisation – a delicate balance between ‘doing the right thing for employees’ versus the need to adopt new technologies and reduce cost.

Consolidation to accelerate

Finally, consolidation, which was already underway in the sector, will only be accelerated. While in the coming weeks we will be talking more about the Alternative Remedies Scheme, what we have seen in relation to CBILS has shone a light on the continued need for more competition and innovation in the SME banking sector.

Summary

For Challenger & Specialist banks and building societies across the UK, major disruption to supply and demand dynamics, the challenges of delivering full services remotely, and managing an unprecedented number of customer enquiries have ramped up pressure on leaders across the sector to make decisions at high-speed. What lies beyond the crisis for the UK’s Challenger & Specialist banks and Building Societies?

 

About this article

By

Ian Cosgrove

EY UK Head of Challenger & Specialist banks

Passionate about helping Challenger & Specialist banks transform the UK banking market. Strategic thinker and relationship builder. Irish rugby fan.