The coronavirus (COVID-19) outbreak is causing widespread concern and economic hardship for consumers, businesses and communities across the globe. The situation is changing quickly with widespread impacts. We’ve prepared some general guidance on COVID-19: What US business leaders should know with respect to crisis management and response, workforce, operations and supply chain, finance and liquidity, tax and trade, and strategy and brand.
Most companies already have business continuity plans, but they may not fully address the fast-moving and unknown variables of an outbreak like COVID-19. Typical contingency plans don’t generally take into account the widespread quarantines, proposed school closures, and added travel restrictions that may occur in the case of a health emergency that could last for an extended period of time.
The crisis raises a number of unique challenges. In PwC’s inaugural COVID-19 CFO Pulse Survey, finance leaders in the United States and Mexico shared their top concerns.
Communication is a key part of effective crisis management. For banks and capital markets firms, this takes on heightened importance because trust and reputation are integral to what they offer clients.
The industry has many stakeholders, but three are particularly important during these challenging times:
When done well, crisis management should let you keep working with your customers in areas such as new lending, refinancing, trading volumes, settlements, collateral/margin maintenance and more.
Cybersecurity is also a key part of crisis management, because there can be additional vulnerabilities in the middle of a storm. This is because of significantly higher levels of remote access to data and core systems, and because employees and management could be more susceptible to social engineering efforts in the midst of a crisis.
We are all starting at the same baseline: Unlike a cyber breach or a reputational scandal, COVID-19 affects all firms, and, for the most part, regulators and clients already understand the basic facts about what’s happening.
Don’t let this crisis distract you from your compliance responsibilities, which in some ways are more important now than ever. Regulatory compliance efforts, such as maintaining capital levels, appropriate review, supervision and surveillance, and anomaly reporting, have to be key priorities.
You’ll also want to look at ways to strengthen your cyber protections because of rising cyber attacks aimed at exploiting the crisis. We recommend taking these steps now:
On-location activity is particularly important for some industry roles, as with traders who need robust, real-time communication and sales teams that are subject to specific compliance monitoring. This creates a variety of workforce challenges that have been largely untested at scale — until now.
You may need to restrict access to some physical facilities, in whole or in part, in advance — before they are exposed to the virus. Some employees may be frustrated when asked to work elsewhere. You may also find that some employees don’t have appropriate physical environments for remote work, or that your supervision and review processes aren’t adequate in those situations. In some cases, you may not have enough qualified employees to do the work that has to be done.
Many of the largest banks have already invoked plans that would split teams into different locations on alternating schedules to diffuse the infection risk. We’ve seen efforts to limit office movement and redesign office space to increase the distance between workers. Some firms are going further, restricting or even banning contractors and other visitors. But no single firm seems to be applying a single method across the board.
We encourage you to consider where your employees will work, how they may feel, and how you’ll lead:
Dealing with stress
Managing your business
Physical supply chains are far less significant for banking and capital markets firms than for companies in other sectors. But, these companies certainly finance clients that are affected by production and distribution interruptions. Banks themselves rely heavily on a network of interlocking vendors, and this has increased with the advent of FinTech. In fact, virtually every aspect of modern banking and markets now depends on the availability of third parties, such as credit card processing networks, lockbox operators, clearing houses and depositories.
On the wholesale level, trading conditions may deteriorate as workers try to adjust to new physical working environments. This is especially complicated given rapid moves by the Federal Reserve and others to shore up the financial system. With fast-moving and unprecedented shifts in behavior, human intervention in market making could be more important than ever, as you need people to do this work.
Credit quality may deteriorate quickly in some areas, especially in sectors or geographies that are hit the hardest. This may overwhelm existing models for Current Expected Credit Losses (CECL), requiring more resources to assess the impact of changing market conditions. This could have an effect on stress-testing in general.
Markets may be highly volatile for some time, and that will make price discovery more challenging. Rapid liquidity shifts and unexpected demand drops are already causing some challenges for market participants that need to “see” pricing. Similarly, volatility and associated dislocations can limit the effectiveness of hedging relationships.
You may find that you need to reassess a wide range of models and analyses for the current environment. For example, decreasing stock price and cash flow forecasts could shift your goodwill assessments. You’ll also want to take into account the recent interest rate drop (and the potential for additional cuts in the future), given the effect on spreads, deposit pricing and funding models as a whole.
Financial firms will also be required to make disclosure(s) about the effect of COVID-19 on their business within financial statements or other SEC filings, based on relevant GAAP and SEC disclosure standards. Affected disclosures could include risk factors, impairment, debt, liquidity, and aspects of Management Discussion and Analysis (MD&A).
Banking and capital markets firms have industry-specific tax reporting and compliance requirements. But the issues they’ll face filing and paying direct and indirect taxes are likely similar to those faced by other industries. For example, subject matter experts may be working at a distance, collaboration tools may not be wholly effective, processes may be undefined and so on. In the short term, these are probably meeting tax compliance requirements and may be manageable, but few firms have tested anything like this at scale over a long period. It should be noted that changing the locations of where employees perform their work may have federal and state tax implications.
We also note that as the government contemplates relief for consumers and businesses, many proposed steps involve adjustments to the tax system. Depending on which measures (if any) are enacted, this could place an additional burden on banking and capital markets tax teams to identify opportunities for companies, as well as to adjust their compliance calculations and processes.
Recent interest rate cuts could affect bank profitability. These, along with a general decrease in business activity, could depress banking profits for some time, and concerns about this have already been reflected in the sharp drops across many firms’ stock prices. This introduces a secondary challenge, because certain deferred tax assets, like net operating losses (NOLs), don’t count fully toward a bank’s regulatory capital requirements. This is likely to compel firms to take other steps to shore up their capital reserves. (It’s important to note, though, that some business lines may actually see higher profits in this market. Banks involved in mortgage refinancing, for example, may actually struggle to keep up with increased demand. Furthermore, any changes to a bank’s operating strategy in this new environment may have significant tax implications.)
Many banking and capital markets firms rely on business continuity plans that have employees working from home or alternate locations. With so much concentration in the New York metropolitan area, this could introduce unexpected tax nexus issues. For example, if a trader works out of a contingency facility in another state for a short period of time, this may not be significant. If the situation persists, though, it may create challenges for companies and their employees as they determine and address the state tax implications that could arise. If alternative work locations include foreign countries, permanent establishment issues also need to be considered.
Specific segments of the population are finding themselves in increasingly vulnerable positions. How you respond could be critical to future customer and employee relationships, and it could damage your public image if not handled well.
It’s not just consumers who will be squeezed. We could also see a rise in payment delays due to cash-flow constraints on businesses arising from a temporary drop in demand for services. The hard part: telling the difference between a routine payment delay and significant deterioration in credit quality.
Banks are working to continue to provide liquidity to markets, which is getting harder given the volatility of the market. But they also need to comply with new Stress Capital Buffer (SCB) rules imposed earlier this year. While many banks lobbied for this change, and it could (in theory) let some reduce their capital buffers, others have observed that new capital constraints could be imposed in the short term, reducing liquidity.
Beyond these pillars, each industry should address some subtleties of its own. Here are some specific considerations for banking and capital markets firms, as well as some guidance on how to respond to the challenges.
Business issues are banking issues. Your retail customers or corporate clients will take steps to manage their own risks. (For example, consumers may use credit lines or skip loan or credit card payments.) You could also see demand change for other financial products. In some cases, clients may become more risk-averse, but you may also see increased refinancing activity for certain products or escalating demand for hedging products.
Capital markets could become less accessible. We have already seen bid-ask spreads widening and volume falling in some asset classes. Amid the surge in treasury activity, there are signs that the repossession market could be under pressure. Depending on how the situation evolves, lending standards could tighten and liquidity could dry up quickly, leading to more credit losses. For now, some counterparties are liquidating assets to deleverage, but the underlying conditions are still fairly strong. If this continues for a longer period, though, it could lead to cash flow challenges for banks and their clients.
Interest rates are lower, for longer. We’ve never seen global interest rates this low at this point in an economic cycle. Now that Fed rates have dropped again, the industry is contending with even lower levels of interest income and more margin pressure. (As we write this, some rates are more than 100bps lower than they were last fall, when annual budgets were set.) Regional banks, which have about two-thirds of their revenue tied to interest income, were already dealing with this before the current crisis when their average ROE slipped in the second half of 2019. On a more fundamental level, banks will be watching to see if the business environment degrades enough to cause real stress for companies with good operating fundamentals. If that happens, defaults and bankruptcies will undoubtedly occur.
In a time of global uncertainty, it’s easy to lose sight of the big picture. This is particularly true when memories of the last recession are still relatively fresh. But it’s worth acknowledging just how different the current situation is from where we were a decade ago:
This is where it makes sense to go back to first principles: What is your company’s reason for being? Especially in a crisis, you’ll want to double down on the things that make your organization stand out. We encourage clients to identify appropriate opportunities for succeeding given the market as it is now and as we expect it to be. From there, you can shift investments to "good" costs and away from "bad," redirecting spending to the areas that will lead to sustainable, long-term growth.
This is also an opportunity to demonstrate your commitment in what you do, rather than just what you say. Your purpose and values aren’t just words on a wall. Now, when some of the people you serve may be among the hardest hit, this is a chance for your leaders to show what your brand stands for.
For now, with such uncertainty around valuations and credit quality, we expect that many M&A transactions will be shelved until the dust settles. But, over time, this environment could easily lead to additional and much-needed market consolidation. Banks with strong balance sheets will likely have an opportunity to acquire weaker competitors at reasonable prices, if the duration of the crisis or its impact extends for some time. In this way, consolidation can help strengthen our banking system by creating opportunities to improve efficiency at scale and jump-start transformation projects.
For some companies, the COVID-19 crisis may also highlight issues that have needed attention and can no longer wait. When your team can’t get to the office, you may discover how many manual workarounds your company has put in place for routine activities. Suddenly, finance and human resource transformation becomes more important. When your data centers are located in affected areas, or scammers try to take advantage of market noise, cloud transformation and fraud/economic crime solutions become higher priority.
Whether you’re trying to protect business integrity, empower your people, make better and faster decisions, or transcend through technology, it helps to take a long view. Once this crisis passes — and it will — where do you want your business to be?
For more than a century, our purpose — to build trust in society and solve important problems — has been at the core of everything we do. We stand ready to help you.
Banking and Capital Markets Consulting Leader, PwC US
Banking and Capital Markets Advisory Leader, PwC US
Banking and Capital Markets Tax Leader, PwC US