COVID-19 implications for banks: evidence from an emerging economy

Abstract

The COVID-19 pandemic is damaging economies across the world, including financial markets and institutions in all possible dimensions. For banks in particular, the pandemic generates multifaceted crises, mostly through increases in default rates. This is likely to be worse in developing economies with poor financial market architecture. This paper utilizes Bangladesh as a case study of an emerging economy and examines the possible impacts of the pandemic on the country's banking sector. Bangladesh's banking sector already has a high level of non-performing loans (NPLs) and the pandemic is likely to worsen the situation. Using a state-designed stress testing model, the paper estimates the impacts of the COVID-19 pandemic on three particular dimensions-firm value, capital adequacy, and interest income-under different NPL shock scenarios. Findings suggest that all banks are likely to see a fall in risk-weighted asset values, capital adequacy ratios, and interest income at the individual bank and sectoral levels. However, estimates show that larger banks are relatively more vulnerable. The decline in all three dimensions will increase disproportionately if NPL shocks become larger. Findings further show that a 10% NPL shock could force capital adequacy of all banks to go below the minimum BASEL-III requirement, while a shock of 13% or more could turn it to zero or negative at the sectoral level. Findings call for immediate and innovative policy measures to prevent a large-scale and contagious banking crisis in Bangladesh. The paper offers lessons for other developing and emerging economies similar to Bangladesh.

Keywords: Banking; COVID-19; Credit risk; Developing countries; Emerging economy.

Fig. 1

Mapping the impacts of the COVID-19 pandemic for banks. Source: authors developed

Fig. 2

Pre-pandemic levels of 2018 total loan outstanding and NPL ratio by bank. Source: Author’s calculations

Fig. 3

Pre-pandemic levels of 2018 risk-weighted asset and capital adequacy by bank. Source: Author’s calculations

Fig. 4

Bank-wise shock to RWA values due to NPL increases. Source: Author’s estimate

Fig. 5

Overall simple average RWA shock by bank size category. Source: Author’s estimates

Fig. 6

Bank-wise capital adequacy ratio under different NPL shock scenario. Source: Author’s estimates

Fig. 7

Sectoral CAR and changes in CAR under different NPL shock scenario. Source: Author’s estimates

Fig. 8

CAR and changes in CAR by size category of banks under different NPL shock scenario. Source: Author’s estimates

Fig. 9

Key stats of CAR and changes in CAR by size category of banks under different NPL shock scenario. Source: Author’s estimates

Fig. 10

Number of banks with less than minimum CAR requirement due to NPL shocks. Source: authors’ developed

Fig. 11

Fall in interest income by bank under different NPL scenario. Source: Author’s estimates