At the beginning of the recent pandemic, a lot of time was spent debating the potential size and timing of the problems that were about to hit national healthcare systems. And while a lot of time and effort was being absorbed by this debate, some countries were busy making valuable preparations. It is now clear that parts of Asia were already prepared in advance for these types of scenarios having learned lessons from the SARS epidemic. It seems likely that those countries that made the right preparations now feel that this was a worthwhile investment.
There are parallels that can be drawn between the impending wave of workout cases that is likely to hit banks in the near future, and the waves of activity that have threatened to overwhelm our healthcare systems. There is a particular focus on workout cases related to small and medium-sized enterprises (SMEs) and individual customers since this is where the highest volume of activity will occur, leading to a heavy load on manual processes. What banks really need to take a view on is what preparations they should be making to avoid the potentially devastating consequences of being poorly prepared for a surge in activity.
This article refers to "workout" cases for simplicity. In reality the severity of problems facing individual companies will lie along a broad spectrum, and as with the healthcare crisis new processes will need to be developed to efficiently triage cases. The countries in Europe that have been worst affected by the previous financial crisis will be amongst the best prepared having been forced to respond and invest in this area recently. Conversely, there are many banks particularly in northern Europe that have not been through a major credit crunch for several decades may find themselves caught off guard by what is about to happen.
The time to prepare is now
One of the defining features of the recent healthcare crisis has been that the problems have come in waves. A period of calm has often been followed by a slow trickle of hospitalisations and then suddenly the flood gates have opened, threatening to overwhelm the available healthcare resources. When a hospital’s resources are stretched to the point of breaking, and doctors are making life or death decisions, it is not a good time to suggest a project aimed at upgrading their infrastructure or an overhaul of the operating model. Such a project would only act as a further pull on critical resources at the wrong time. The best time to prepare for a period is always before the crisis takes hold.
Anyone with experience in banking knows that lending is also a cyclical business meaning that problems also come in waves. In other words, problem loans tend to cluster through time. And the reason that credit problems tend to cluster through time is because the problems tend to have a common cause: most often linked back to trouble with the broader economy.
But is there actually going to be a wave of workout cases off the back of the COVID-19 crisis? The negative impact on gross domestic product (GDP) for some countries, and particularly for certain sectors, has been unprecedented. But on the other side of the debate, the monetary and fiscal stimulus from policymakers has also been unprecedented. Optimists point to the fact that the government support might be held in place until the economy recovers, mitigating any downside. But it is also likely that some sectors will see demand rebound slowly, leading to a period of stress after support is withdrawn. Credit risk is an asymmetric risk, even if the economy rebounds from the pandemic stronger than it was before, it is clear that individual companies will have suffered to very different degrees. If half the portfolio improves and the other half deteriorates this will still lead to an increase in the number of workout cases.
It is by no means a certainty, but banks can’t ignore the fact that there is material chance that an increased wave of workout activity might be coming in the near future, and taking a “wait and see” approach could prove dangerous. Some of the preparations take time to implement and so banks will need to take action in advance rather than waiting until the number of cases increases before making changes. This is analogous to how critical resources like personal protective equipment (PPE) and vaccines have taken time to be approved, funded, manufactured, and delivered – there has been a clear benefit for those that have made their preparations in advance. In the event that a large wave does not arrive, investing now will mean that banks are better prepared for the next period of stress whenever that arrives.
THE COST OF BEING UNPREPARED
It is an interesting thought experiment to consider what kind of financial return $1 billion of governmental “pandemic preparation” spent in 2019 would have generated in terms of mitigating the subsequent impact on the economy during 2020. Imagine if western nations had entered 2020 with a scaleable testing apparatus and a large onshore vaccine manufacturing capability. The cost to the global economy of being unprepared can now be measured in trillions of dollars. But the damage of being unprepared goes way beyond financial costs. It has destroyed lives and damaged the reputations of many political leaders.
A lack of preparation can lead to damage to a bank’s reputation and in extreme cases can raise uncomfortable questions regarding a bank’s capital position. Such problems inevitably lead to friction with regulators which typically brings with it a high cost of remediation.
The main concern for banks should be an increase in workout cases from SMEs and individual consumers. Large corporate workout cases, such as the default of a national airline carrier, will naturally be handled by an experienced team of restructuring experts. But let’s imagine a situation where a team of SME case officers which normally handle 10 case files per week suddenly finds themselves handling 50-100 workout cases per week.
The restructuring or foreclosure of a loan needs to go through a proper governance process to ensure customers are being treated fairly and consistently. In this analogy, the workout case officer during a credit crisis is like the doctor on the COVID-19 ward. If the right preparations have not been made, the doctor suddenly finds themselves having their time split across triaging decisions, diagnosis, administering treatments, training new staff, data retrieval, filling out paperwork and the management of stakeholder communication. As the workload rises the situation quickly becomes untenable. Such an approach not only leads to sub-optimal and inconsistent outcomes it also leads to a poor audit trail which can cause big problems further down the road.
The key building blocks that need to be prioritised now to maximise preparedness and to mitigate potential downside risk.
Perhaps the main advantage of a traditional bank is the experience they have accumulated in managing their way through a full credit cycle, many times over. The new policies put in place and the decisions that are made during a crisis period are likely to have a major impact on the bank’s reputation for many years into the future. As a result, there needs to be strategic framing of the response, taking into consideration the multi-year consequences of any actions taken even if these actions are implemented in some cases with tactical solutions.
The banking industry has spent many years exploring the benefits of taking a more “customer centric” approach to solving their clients’ “unmet needs”. Arguably a customer’s needs are never higher than when they have run into credit problems. And the main creditor bank’s solution to the problem is usually going to have a material influence on the future prospects of the customer. As is often stated, coming to a customer’s support during a time of difficulty is an opportunity to build a lifelong relationship. That is not to say that the bank should just throw money at the problem for the benefit of the customer. This is a time, however, to ensure that the customer’s perspective is being heard and considered during any deliberations.
As the credit cycle turns, policies and practices will need to be adapted to reflect shifts in risk appetite, but also to support efficient processing of cases. New solutions for dealing with customers need to be found incorporating elements of self-serve and payment holidays to take the load off the heavy workout processes that would otherwise be triggered. Once a customer enters restructuring a bank will need to prepare blueprints that can be applied in a standardised way to cases with common problems, leaving any bespoke restructuring to the highest value cases. New approaches will also need to be developed for customers with government guaranteed loans, particularly where customers also have non-guaranteed loans and any restructuring needs to preserve the guarantee. In short, best practice approaches need to be developed and deployed at scale.
There are many different types of decision that need to be made from the onset of credit problems to the point when the case is considered closed. In all situations, the person taking the decision will want to have the best information readily at hand to improve the speed and quality of their decision. There will be common elements of data being pulled across customer financials, payment history, loan and collateral details. As such, there is nothing to stop a bank from batch processing this data in advanced to ensure that it is already available when it is needed or so that it is easy to refresh or confirm with the customer when needed.
In our analogy the hospitals quickly discovered that it wasn’t just about getting hold of more doctors and nurses. Bringing the situation under control required the definition of new triaging approaches, changing the routes for people around the hospital to avoid mixing COVID-19 and non-COVID-19 patients, ordering PPE and ventilators, working out which non-essential appointments could be cancelled to free up capacity, replanning wards to increase bed capacity, defining treatment protocols to make it quicker to decide what to do for individual patients, etc. Making such dramatic changes to an operating model is difficult even during times of quiet. Implementing changes during a time of stress is likely to lead to quick fixes that lead to more pain further down the line. The hospitals reportedly had a better time dealing with the second wave in the winter having learned from the first wave in the spring. Banks probably won’t get two chances at this and need to be open to the learnings from past crises.
The increase in activity will need to be met with an increase in resourcing, and these resources need to be planned for ahead of time recognising that there will be increased demand across the whole industry when the problems start. This will likely include elements of hiring, contractors and outsourcing to third parties. However, as will be described in the remainder of this section, we believe it will not be enough to simply scale the resources while keeping the operating model unchanged. Difficult decisions are always going to fall back on a limited group of experienced professionals. Hiring in more staff without the right background could actually lead to an increased drag on scarce resources as these staff need to be trained. And it would be better, of course, if such training took place ahead of time rather than waiting until the surge in activity begins.
Data-driven decision support is going to be a key element in alleviating pressure on expert resources. As such, the revised operating model should include a centralised analytics team that can act as a hub for data extraction, cleaning, preparation and insight generation. One area that can be often neglected is the understanding and embedding of sectoral dynamics. Below is an example of the different impact on solvency and cashflows for a sample of sectors laying at different point on the spectrum covering two different scenarios for how the pandemic could evolve from here.
Bringing cases to the point of closure quickly will require a streamlining of the workflow between team members combined with automation of fulfilment for elements of the journey. The adoption of digital signatures, and pre-population of digital forms, is one area which can be implemented and adapted quickly enough to be available in the near term. Many banks have also created dedicated customer messaging portals for managing interactions in a transparent and secure way.
Changes to policy are going to be a crucial component in directing the flow of cases, managing the workload and balancing the needs of both the bank and customers. This is going to be an ongoing process and will therefore require a dedicated team that can dynamically manage policy updates. This team will need access to multi-disciplined team of experts with backgrounds covering sanctioning, restructuring, conduct and legal.
Management Information (MI) and Reporting
Good MI and Reporting will be essential for a number of reasons. Firstly, this is going to be an evolving situation meaning that resources will need to be dynamically allocated through time based on complete and timely information. Secondly, there is going to be an element of “test and learn” with the impact of new policies and strategies needing to be measured and fed back into improvements to the approach. Finally, senior stakeholders and external regulators will be taking a keen interest in how the situation is evolving and will need to be kept abreast of developments through a clear and concise management information system (MIS).
When considering upgrades to lending and credit infrastructure, banks are encouraged to take an end-to-end perspective. As such any strategic upgrades to a bank’s workout and collections infrastructure should be closely coordinated with these broader programs of work.
Unfortunately, the lending transformation work ongoing at most banks isn’t going to be ready in time to satisfy all the requirements of the data-driven operating model that we described in the previous section. However, the work will go a long way to defining the blueprint for a future state architecture and operating model that can then be fed into the broader requirements of any end-to-end transformation programs.
The ultimate aim should be a seamless set of workflows that manage a customer and their loans from cradle to grave built upon strategic systems with clean, comprehensive and common data sources. For most banks, strategic platform is something they are hoping to have in place for the next crisis but won’t be available for this one.