How can banks minimise COVID-19-related losses? asks GCD study

The amount a bank loses on defaulted secured loans depends more on when it realises the loss than on the date of default, reveals the latest Downturn LGD Study from Global Credit Data (GCD). This suggests that banks – bolstered by much-improved capital buffers in the wake of the global financial crisis of 2008-2009 – may be able to minimise losses incurred from COVID-19-related defaults by waiting to sell collateral until it can fetch a better price during an economic recovery. This is not a catch-all solution, however. Capital buffers give banks more flexibility to choose when they sell collateral, but not all loans are secured. This means banks do not always have control over when they realise losses.

Even when they do have collateral, picking the right moment can be a challenge and there is always the risk that an outburst of defaults will force them into selling earlier (and cheaper) than they’d like. “Waiting longer to recover defaulted loans comes with its drawbacks,” explains Nunzia Rainone, Executive at GCD, “especially for unsecured loans, where GCD historical data consistently show that the longer the recovery period, the higher the loss.” This latest report from GCD expands on its recent LGD Report for Large Corporates 2020, looking at historical data on loss given default (LGD), the amount of money a bank or other financial institution loses when a borrower defaults on a loan.

The two data sets used for the study – one for corporates, another for banks and non-bank financial institutions – total over 88,000 non-retail defaulted loans from around the world. Covering two previous crises – the 2001-2002 dot-com bubble and the 2008-2009 global financial crisis – they help shed light on what banks can expect in terms of recoveries in the wake of the current crisis.

“With huge uncertainty still surrounding the impact of COVID-19, this study looks specifically at the historical effects of previous downturns on bank credit losses across various debtor types, industries, and regions, with a view to helping banks understand the high-level impacts of a downturn and confirm some stable credit loss drivers,” comments Richard Crecel, Executive Director, GCD. “The data consistently confirm that during and after downturns, secured loans were always less risky than unsecured loans, and factors such as time to resolution matter.”

However, analysis of historical data only tells part of the story. There are other elements to be factored in, including banks’ independent inputs for variable such as macroeconomic forecasts, portfolio composition, and the differences between the current and previous crises. Combined with these, the data in this report equip banks with the fundamental tools to make accurate adjustments to their credit loss estimates for the COVID-19 crisis.

“For all the uncertainty, statistical analysis of historical observed LGD is still by far our best tool for determining future estimates,” concludes Crecel. “With this in mind, we offer our Downturn LGD Study, in the hope that it can form part of the raw material from which banks can form their own accurate projections and help steer a course through today’s challenging landscape.”

Click here to download the full report.