PwC: Decisive action needed from UK banking sector
UK Banks are being urged to act now to recover from the uncertainty of COVID-19. Cost and asset quality are the two issues the banking sector should prioritise as they restructure and seek to unlock value, recommends Pricewaterhouse Coopers (PwC).
In the consultation paper, Act Now to recover UK Bank Restructuring 2020, PwC focuses on tools and solutions to enable the banking sector to recover from the global COVID-19 pandemic.
“With the UK banking sector facing significant uncertainty, decisive action counts. The ability of the economy to recover from the current recession depends on the strength of its lenders, meaning it is critical to act now,” Michael Magee Head of Financial Services Deals, PwC UK.
Macro conditions in 2020 has been one of the most challenging operating environments in recent history. Q2 saw a contraction of ~20% with other key indicators such as the labour market under intense pressure. Q3 is expected to show a slight recovery.
“Our view is we are at a critical juncture depending on the impact of any second wave of COVID-19 cases, compounded by the end of government support schemes,” commented Magee.
“Banks have so far proved resilient, with average CET1 of 15.4% in Q3. However, with further cuts to ultra-low rates, a potential no deal Brexit and COVID-19 all looming, they face no small hurdles,” said Magee.
1 Focus on cost
The ultra-low rate environment is driving margin compression and putting pressure on UK banks to place costs as a strategic priority. Cost is considered a strategic priority for the following reasons:
- Low interest rates will continue to apply pressure on margins
- Leading UK banks are accelerating cost-out programmes
- Banks face pressure to boost productivity with digitalisation
- Strategic cost levers are required to deliver on ambitions but should balance with prioritising strategic investment
“Meaning now, more than ever, cost reduction is a critical lever for banks seeking to recover their cost of capital, stresses PwC.
Banks are using strategic cost levers to deliver radical change, these include:
- Simplify businesses and products
- Drive shift to digital across channel mix
- Re-engineer front-to-back processes
- Optimises locations and workforce
- Simplify the organisation structure
- Supply chain optimisation and sourcing
- Automation to accelerate productivity
2 Asset quality
Without successful strategies to manage asset quality COVID-19 and asset impairments are likely to reduce the risk-bearing capacity for banks to support the real economy.
“The rise in defaults from growing unemployment and the increasing number of corporate bankruptcies have caused a 22% increase in non-performing loans (NPL) since the turn of the year, with NPL ratios as high as 2.8%,” comments Magee.
According to statistics from PwC in Q3, one in six mortgages in the UK (1.9 million) were subject to a payment deferral. Lloyds offered 477,000 mortgage holidays, with 250,000 offered by NatWest and 123,000 from Barclays. One in four workers have been furloughed at a cost above £41 billion. On November 5, the chancellor confirmed the extension of the Job Retention Scheme due to end in March 2021. The additional cost of the extension is estimated to be £1 billion a month for 1 million people on the scheme.
There are several tools available to banks based on asset quality, advises PwC. These include:
- Disposal of performing assets in higher-risk sectors where provisioning has taken place to reduce concentration, future collection risk
- Capital relief trades for SME / corporate books to improve CET1
- Diagnostic assessment and customer segmentation to inform operational planning and collection strategy
- Managed solutions providing capacity, capability and outsourcing of key services to manage peak demand
- Restructuring of key NPL exposures with potential private money partnering
- Disposal of NPL portfolios likely to be delayed to when full provisioning is performed by banks
“Cost and asset quality are two of the most pressing issues that banks should prioritise as they restructure their businesses and seek to unlock value. Treating cost as a strategic priority is the key enabler to improving efficiency. Having a clear focus on managing asset quality, and any deterioration, will ensure banks are well placed to deliver a continued flow of capital in the economy, concludes Magee.