LENDING TO FIGHT THE PANDEMIC - How the dynamics of Retail Credit will change in Brazil, and what should lenders do now to respond - Oliver Wyman
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LENDING TO FIGHT THE PANDEMIC How the dynamics of Retail Credit will change in Brazil, and what should lenders do now to respond Ana Carla Abrão, Partner Nuno Monteiro, Partner Pablo Haberer, Partner João Paulo Curado, Principal April 2020
THE IMMEDIATE CRISIS IS IN THE REAL ECONOMY, BUT THE CREDIT SECTOR IS
STARTING TO SHOW SIGNALS OF IMPACT – WHICH MAY AMPLIFY THE RECESSION
Brazil: Credit market growth and GDP are ...and during periods of crisis, lending contraction may
strongly correlated… amplify the recession
Credit balance - real YoY growth Market consensus expects GDP
for 2020 to contract at least - Less credit
GDP - real YoY growth
1.0% vs. the +2–3% at the
30% beginning of the year
25% Consumers Businesses
20%
15%
No new
10% Slower growth
investment
5%
Higher Falling asset
0% interest costs/ prices and
defaults lower wealth
-5%
-10% Difficulties
Lower
refinancing Rising defaults
-15% spending
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 existing debt
Government anticipated year-end target
Deeper
risk free rate (SELIC) decrease to
stimulate credit availability by lenders
recession
There is no off-the-shelf cure for the complex economic effects of the COVID-19 crisis, but credit is definitely at the
center as a key enabler to lessen the burden on individuals and companies
Sources: World Bank data; BCB Séries temporais; Oliver Wyman analysis
© Oliver Wyman 2
IN THIS REPORT WE DRAW FROM THE LEARNINGS OF PREVIOUS CRISES AND THE
INITIAL COVID-19 ANSWER TO DISCUSS
01 02
How the dynamics of Retail Credit will change What should lenders do now to respond
in Brazil
• COVID-19 crisis is in the process of delivering a global • Emergency mode: take care of the basics for business
recession, generating both a cash crunch and a surge in the continuity; contribute to the mitigation of the crisis by providing
cost of uncertainty forbearance and aid to affected borrowers
• Individuals and SMEs require immediate additional cash to • Immediate response (today to next 12 weeks): simulate the
cover their short term expenses, generating an initial surge financial impacts of the crisis; establish a COVID-19 credit
in the demand for credit playbook with “triage & treatment” approach; work together
with the government and other lenders to ensure the added
• Reacting to the increased risk and complexity in the scenario,
liquidity to the Financial System reaches SMEs and individuals
banks and other lenders reduce credit supply
in need for it
• Brazilian Government, as done in other geographies, is
• Medium-term strategy: pro-actively adapt to the new business
implementing a broad stimulus package to mitigate (but not
environment, balancing the defensive with an offensive
avoid) COVID-19 effects
agenda by re-assessing financial plans, credit strategy and
initiatives prioritization
© Oliver Wyman 31 HOW THE DYNAMICS OF RETAIL CREDIT WILL CHANGE IN BRAZIL
COVID-19 CRISIS ARRIVES IN THE EXPANSIONIST PART OF THE CREDIT CYCLE AFTER
A SLOW AND LONG-WAITED RECOVERY AND WILL IMPACT CREDIT AND NPL VOLUME
Non-Performing Loans Credit volume outstanding
% of total loans in BRL BN
Early signs of increase in unemployment and Credit was recovering from 2015’s slowdown,
business bankruptcies, as suppressive measures but despite an increased demand from SMEs and
take place, indicate NPLs likely to grow in response individuals it is likely that credit supply will reduce
8 2,000
6 1,500
4 1,000
2 500
0 0
2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022
SMEs PJ1 PF2 Trend PJ PF Trend
Interest rates • COVID-19 crisis arrives in the expansionist part of the credit cycle in
% a.a. Interest rates expected to increase as Brazil, which is particularly concerning for Retail lenders
investor confidence falls and NPLs grow
50 – Likely NPL increase in vintages that were already originated in
growth mode
40 – Little room to maneuver and avoid/ mitigate credit losses
30 • Despite surging demand for cash from Retail clients, we expect (and
20 start to observe) little appetite from lenders in supplying the much
needed credit
10 • Individual lenders and the government will have to work together to
0 provide aid and fuel the economy – with the required guard-rails to
2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 maintain the stability of the system
PJ PF SELIC Trend
1. Pessoas Jurídicas, Brazilian term for “legal entities”, includes Corporates, SMEs and individual micro-entrepreneurs (MEI); 2. Pessoas Físicas, Brazilian term for natural person or individual
Source: Series temporais (Central Bank of Brazil) for total credit (incl. earmarked); Relatório de economia bancária, 2018 (Central Bank of Brazil); Oliver Wyman analysis on illustrative trends
© Oliver Wyman 5HOW THE DYNAMICS OF RETAIL CREDIT WILL CHANGE IN BRAZIL?
Understanding how the COVID-19 crisis will change Retail credit is critical for lenders to address the upcoming
challenges, calibrating the credit supply with a changing demand and adequately responding to government stimulus
COVID-19 crisis has been severing the Credit supply shock
flow of goods and people, hindering
economies and is in the process of With higher uncertainty and complexity in the macro
delivering a global recession scenario and the emerging real economy crisis,
investor confidence goes down and shift capital to safe
havens, reducing appetite to lend
Credit demand surge Government stimulus
Individuals and firms face a To provide a safety net to the
cash crunch as a result of the economy, Government launches
efforts to limit the spread of stimulus packages that aim to
the virus, leading to a strong mitigate effects of the crisis and
increase in the need for credit Crisis in the real economy bridge the mismatch of credit
demand and supply
© Oliver Wyman 6CRISIS IN THE REAL ECONOMY
COVID-19 is having profound impact in the real economy, generating both a cash crunch and a surge in the cost
of uncertainty – the longer it lasts, the bigger the impact in the economy
The cash crunch
3 scenarios for COVID-19
in Brazil • Significant demand surge resulting from national suppressive measures to close non-
essential businesses/companies and adopt social distancing
1. Outbreak suppression in 4–6 months • For many small companies, self-employed and informal workers, a month of closure is
– Early and aggressive suppression ruin. Two months is a catastrophe that leads to a domino of bankruptcies and layoffs
measures contain outbreak
– Population largely complies with – SMEs, particularly those in affected industries (travel, non-food retail, hospitality),
public health directives and informal workers will have considerably lower cash-inflow to cover their
expenses, consuming working capital and reserves
2. 6–12 months to rein in pandemic
– Brazil isn’t able to suppress the virus
– Many of the struggling companies will implement cost reduction measures, and
with rates continuing to increase unemployment is likely to rise – as it is already happening in other geographies –
beyond 8 week window bringing even more workers into the cash crunch
– External factor1 to decrease CFR2
or helps contain spread
3. 12+ months ongoing epidemic The cost of uncertainty
– Brazil is unable to contain
outbreaks; virus spreads widely, • Flight to quality: rapid deterioration in the value of higher-risk assets and companies’
affecting ~20–60%3 of adult
stocks (especially in sectors mostly impacted by the crisis, e.g. travel), shifting investor’s
population in next 2 years
capital to safer assets and reducing balance sheet availability
– Mortality rates do not decline,
placing significant strain on or • Possible impact on international trade due to border closures and the ripple effect of
overwhelming health system the slowdown in large economies (e.g. USA, Europe and China)
– Vaccine/immunity after infection is
required to halt progress of disease
1. Viral mutation affecting virulence, early identification and improved treatment, seasonality; 2. Case Fatality Rate; 3. Harvard School of Public Health
Source: Oliver Wyman analysis
© Oliver Wyman 7CREDIT DEMAND SURGE
Individuals and SMEs will be strongly impacted by this crisis, and will need credit to fulfill their short-term cash flow
imbalance during the crisis
Lockdown is impacting all sectors with SMEs and informal How resilient are companies and individuals to cash shortage?3
the most vulnerable businesses
# of companies in MM1 Labor-intensive and low-wages Industries are more
19.2 exposed to the crisis, holding 15% and 30% fewer
0.9
1.9 Medium and large
Small - + “cash buffer” days, respectively
Level of impact
6.6 Micro
Resiliency by size of the firm
Small business
and entrepreneurs
High tech manufacturing
represent 90% of total 9.8
Repair & maintenance
Individual (MEI)
CNPJs, 27% of GDP and
+
Metal & Machinery
44% of total payroll
High tech services
Wholesalers
Restaurants
Real Estate
# of individuals in MM2
Retail
93.5
-
Formal employee
- Cash buffer to withstand crisis period/Resiliency of the industry +
Level of impact
55.1
Informal employee from Resiliency of the Capital-intensive and high-wages
Informal sector 18.2 private sector/family biz employer play a key Industries are more resilient to the
represents 41%
Informal employer/ role for individuals, crisis, holding respectively 41% and
of employed population 20.2 self-employer + even for formal 15% more “cash buffer” days
2020 employees than average SME
Feedback loop between cash crunch on SMEs and individuals – one reinforces the other
1. Data Sebrae as Mar 2020; 2. IBGE as Dec 2019; 3. Farrell, Diana & Wheat, Chris. “Cash is King: Flows, Balances, and Buffer Days” JP Morgan Chase Institute, Sep 2016
© Oliver Wyman 8CREDIT DEMAND SURGE
Surge in demand for credit will be concentrated in unsecured and short-term instruments – likely reducing in vehicle,
real estate and long term/investment financing
Credit lines origination for Companies and individuals Non-exhaustive
In billions of BRL, Mar/19 to Feb/20, non-earmarked credit
Dynamics
SME’s credit lines during crisis
Uncertainty as companies will discount more of their
Factoring/receivables 604 ? receivables, and at the same time the volume of receivables
Working capital 230 reduces with the diminishing consumption
Guaranteed account 177 Survival lines for SMEs specially will experience an increase
Rural credit 45 in demand as a way to ensure liquidity during the crisis
Real state credit 8
Individuals’ credit lines
Credit Card 1,315 ? Uncertainty given a reduced overall household spending
due to the lockdown, counter-balanced by an e-commerce
Renegotiation 381 and card-not-present transactions to increase in response
Overdraft 241
Most individuals line of credit will see a spike in demand, as
Payroll 211
people losing their jobs/not receiving their paycheck will
Auto 126 need turn to other sources of liquidity
Unsecured loan 124
Financing 4
0 200 400 600 800 1,000 1,200 1,400
Increase demand
Decrease demand
Source: Series temporais Central bank of Brazil
© Oliver Wyman 9CREDIT DEMAND SURGE
SMEs and individuals will seek additional credit with sources they already have, and then “go down the scale” – paying
higher spreads
Credit market share1 How are they funding this credit? How they are lending?
SMEs Individuals Funding rates2 Lending rates3 Dynamics
(% per year) (% per year)
Total 931 2,005 SMEs Individuals
If already have access to formal
Leadingbanks 349 1,600
credit market, borrowers will
~4.8% 10%–50% 30%–120%
(1st stop) (66%) (80%) most likely ask for more credit with
their banks
Small, medium If topped limit with current lenders,
56 291
and cooperatives ~7.5% 7%–100% 30%–350% look for alternatives – Cooperatives,
(23%) (15%)
(2nd stop) medium/small banks, ….
Fintechs and 526 114 …or challengers such as fintechs
financeiras (11%) (6%) ~6–12% 10%–120%+ 30%–500%+
(3rd stop)
and Financeiras
If left outside or reached limit with
Informal credit the formal market, borrowers will
(last stop) also seek informal credit (e.g.: payday
lenders, factoring)
With the imminent increase in demand, lenders will see an overall rise in applications
1. IF Data (Central Bank of Brazil); 2. Broker’s platform; 3. Considers lending rates publicly disclosed by 30 financial institutions for unsecured personal credit and 44 financial institutions for SME working capital
© Oliver Wyman 10CREDIT DEMAND SURGE
The rise in demand will not be homogeneous: the profile of “who’s knocking on the door” will be different and require
different strategies from lenders to capture the amplified skews of the portfolio
Who’s knocking on the door What they can turn out to be
Good borrowers
? Borrowers that did not need credit before
– That did not need credit before
– That had credit but need additional aid for
Borrowers with credit but with the need for
? additional aid to survive the crisis
the rainy days, and will recover later on
– Which were served by other lenders, but
Borrowers that reached their reached their limit with them
? indebtedness limit Usually good borrowers, but that may become
Borrowers that were served by other lenders,
? delinquent given the current environment –
opportunity for later recovery
? and may have reached their credit limit there
Bad borrowers
Borrowers that were good in – Who were good in other institutions –
? other institutions difficulty to accurately classify
– Who were already knocking, but may
Borrowers who were being rejected, but be mistaken for good ones in the
? may be classified differently on the changing environment
changing environment
– Known to be bad
? Borrowers known to be bad (blacklisted) Traditional and innovative ways to fraud
© Oliver Wyman 11CREDIT SUPPLY SHOCK
The last period of stress in the Brazilian economy shows that the contraction of the economy is amplified by an even
stronger contraction of credit supply – i.e. credit-to-GDP reduces even though GDP is already falling
Behavior of credit key indicators pre- during and after crisis
Crisis periods are followed by contraction in available credit, with Contraction is both caused by, and refueled by, the delinquency
recovery to pre-crisis levels taking significant time increase during the crisis, which also takes some time to recover
Credit balance in relation to GDP Spread of non-earmarked credit lines¹
% p.p.
60% 60
50% 40
20
40%
0
30% 2005 2007 2009 2011 2013 2015 2017 2019
PJ PF
20% Non-Performing Loans (>90 days of delinquency)
% of loans
10% 8
0% 6
2007 2009 2011 2013 2015 2017 2019 4
2
Legal persons (Excluding financial institutions)
0
Natural persons 2005 2007 2009 2011 2013 2015 2017 2019
Crisis period
PJ PF SMEs2
1. Figures until 2012 consider spread values with a break by type of operation (pre-, post-fixed and floating for PJ, pre-fixed for PF, from 2013 on, the spread in the composition of the ICC (Credit Cost Indicator);
2. PJ figures include SMEs and Non-Financial Corporates; Source: Banco Central do Brasil; Oliver Wyman analysis
© Oliver Wyman 12CREDIT SUPPLY SHOCK
Increased credit risk during the crisis is the aggregate factor that strongly contributes to the credit supply shock,
but challenges and complexity emerge for all links in the credit value chain
Credit value chain Key challenges emerging from the crisis (detailed in the appendix)
Client acquisition Surge in number of clients seeking credit, favoring large banks that serve as a
= Favors the large “first stop shop”, which results in adverse selection for other players
Change in customer profile, mix, and the new macroeconomic scenario mean that
Credit decision
credit models and policies used during “business as usual” are much less
= Less accurate
accurate in predicting credit performance – lenders needs a COVID-19 playbook
Higher uncertainty and complexity causes investor confidence to go down and
Funding
shifts capital to safer assets, increasing funding costs, with strong impact for
= More expensive
fintechs and smaller lenders who are Balance Sheet-constrained
Increase in delinquent volume is driven by constraints in the capacity to repay
Collections (rather than unwillingness to pay from borrowers), which makes debt
= Less effective collection efforts ineffective – particularly in a moment where “hard” collection
is not advised
Strong, broad-service digital channels are even more necessary now, given
Customer service
unavailability/sanitary risks of brick-and-mortar channels, associated with
= More digital
potential operational challenges to call centers
© Oliver Wyman 13As of April 2nd 2020
GOVERNMENT STIMULUS
Brazilian Federal Government has committed so far with >BRL400 BN (USD 80 BN) to mitigate emergency credit
demand and boost supply – given the actions from other countries, more is likely to come
Overview of stimulus package (highlights)
Welfare & living costs Impact on credit demand
• Providing basic income (BRL 600/person/month) for 3 months for vulnerable population (e.g. informal workers) and
supplementary income to workers with reduced wage – totaling + BRL 55 BN expenditure • Mitigate disruption of income
for most affected sectors of
• Re-routing and increase budget of Health Ministry and SUS – at least ~BRL 11 BN (e.g. cancelling 2020 census)
the population, which
• Inclusion of +1MM people in the program Bolsa Familia (financial support for low income families), equivalent to ~BRL 3 BN indirectly reduces short term
• Anticipation of 13th monthly salary for May and allowing further withdrawals of FGTS (Employees indemnity public fund) – impact on revenues for
totaling BRL 46 BN essential services
• National and state-level decisions to suspend collection of bills of essential services (e.g. electricity, telco)
• Mitigate impact on companies
• Support to the states and municipalities: suspending re-payment of state debts, guaranteeing transference of constitutional by postponing cash outflows
funds – total package ~BRL 88 BN (e.g. taxes paid), as well as
• Several measures by public and private banks to extend loan repayment deadlines, reduce interest rates and increase specific actions to
available credit for individuals maintain jobs
• In negotiation – approval of separate “War Budget” until the end of the year
Business support
• No taxation for products related to combat against coronavirus, waiver in tax payment for SMEs
Impact on credit supply
• Flexibilization in work regulation (hours bank, work shift and temporary reduction of wages)
• Government subsidization of business loans (no interests) to pay for employees of small businesses for 2 months • Government-backed credit
• Forbearance and more flexible renegotiation of performing loans lines for borrowers not within
the risk appetite of the
• Specific SME credit lines at reduced interest rates provided by public banks (CAIXA, BB, BNDES, state banks)
private sector
• Special credit lines to medical institutions by CAIXA
• Increase liquidity available for
Monetary policies lenders to offer the required
• Interest rate reduction to 3.75% (50 bps) credit support to individuals
• Central Bank interventions in the FX market to prevent liquidity disruption and businesses
• Liquidity support with expected impact of ~BRL1.2 TN and capital relief for the banking sector
See further details on Central Bank initiatives in the appendix
Source: Central Bank, Observatório de Política Fiscal – IBRE/FGV
© Oliver Wyman 142 WHAT SHOULD LENDERS DO NOW TO RESPOND
FINANCIAL INSTITUTIONS NEED TO BE PROACTIVE IN RESPONDING TO THE
PANDEMIC, DELIVERING SOLUTIONS FOR THE SOCIETY – AND THEIR OWN FUTURE
Not exhaustive
Lower probability of an Lower risk of
expressive loss scenario inappropriate measures
taking place by the regulator
Lower risk of a populist Contribution for an
Motivation to
action by the federal organized path as a
act proactively
government way out to the crisis
Risk avoidance of Contribution for a faster recovery
financial system losing of the economy once the health
credibility crisis is overcome
This is not a standalone effort: individual lenders need to work on their own response programs,
but FIs and the Government need to coordinate holistic solutions and ensure adequate incentives
© Oliver Wyman 16LENDERS SHOULD MOVE QUICKLY TO RESPOND
Starting now in emergency mode to (i) provide urgent aid to borrowers, and setting up an immediate response focused
on (ii) financial impact scenarios, (iii) COVID-19 credit playbook, and (iv) coordinated relief effort
Emergency mode Immediate response Medium-term strategy
6–12 Focus of this document 3–6
Now
weeks months
The basics (II) Financial impact scenarios • Strategically planning the
• Assessing increased risk by sector/geography, in light of alternative medium/long-term response
• Employee protection and
pandemic scenarios – Managing the recession
Business Continuity Measures
• Evaluating overall financial projections in light of possible (leading banks have
• Map the high-level P&L prudential/public policy scenarios and bank response strategies recession playbooks)
and Balance Sheet impact – Expanding business lines
of the crisis
(III) COVID-19 credit playbook • Rapidly repositioning the
(I) Forbearance as-is portfolio in line with new
• Managing “in-vivo” potential business response linking active urgent strategy and risk appetite
• Contribute to the mitigation of decisioning and tactical changes to longer-term strategy
the crisis by providing aid to • defining a playbook with client-level financial support strategies • NPL management
affected borrowers (decisioning & triage, required buffer, post-crisis support) • Balancing the defensive with an
offensive agenda by
reprioritizing initiatives
(IV) Coordinated relief effort
• Working together with the government and other lenders to ensure
the added liquidity to the Financial System reaches SMEs and
individuals in need for it
• Public advocacy and active solution design (local/regional)
• External communication vis-à-vis investors and the community
© Oliver Wyman 17EMERGENCY MODE: (I) FORBEARANCE
After taking care of the basics (Employee protection and BCP), first priority should be quickly operationalizing
forbearance programs, providing immediate aid to debtors who need it
Now: Providing forbearance to those who need it
• Brazilian Central Bank estimates a potential impact on ~BRL Segment Treatment objectives
3.2 TN loans that could qualify for the current
renegotiation stimulus Support and help to navigate
Clients not
• Given the speed of the current crisis, focus should be on impacted or • Maintain constant
rapidly launching a forbearance program mildly communication regarding
– Significant credit impacts are beginning to arrive impacted commitment in time of
severe stress
– Forbearance to be explicitly and closely managed in terms
of risk and controls Support and help to navigate
• Customer care is critical; a successful program is one that • Implement rapid program to
– Responds to client needs Clients already identify clients impacted by
– Can be operationalized quickly impacted by COVID-19
– Fits within bank financial constraints COVID-19 who • Provide widespread support
need help now that can be operationalized
• Rapid mobilization will help get relief to clients in need and quickly and seamlessly
send a strong signal to external parties (customers, market,
• Offers are not differentiated,
regulators) despite uncertainty
with objective of providing relief
in time of high uncertainty
The follow up priority should be making any refinements, as well as developing high-level plans for
both downside (e.g. permanent mods) and upside (supporting strong customers) as the crisis unfolds
© Oliver Wyman 18EMERGENCY MODE: (I) FORBEARANCE
Oliver Wyman has developed a framework to inform decision-making, focused on top-of-the-house strategy
and trade-offs, Product-level tactics and Operations to ensure a strong forbearance
Checklist Example: SME working capital loan
Top-of- • Isolate and size high-priority areas based • Map scope and focus of SME working capital relief for
house on available operational/client data segments/regions more affected, simulating financial
strategy (e.g., in-bound requests) requirements and results across simple scenarios
• Identify short-term constraints (e.g., liquidity,capital,
operations) for providing comprehensive relief
• Create offer construct with basic terms and simple • Offer construct with basic terms and rules
rules for client eligibility – 2–3 month payment deferral, waiver on interest
• Which clients are eligible and fees
Product-
level • Which levers to pull, for how long – Within list of affected segments, or proof of revenue
tactics • Design simple and well-defined approval process decline due to COVID-19 impact
to minimize resource strain or potential • Simple and well-defined approval process
regulatory/compliance issues – Verification via bank app for minimal tollgate while
expediting process
• Conduct proactive client outreach across range • Banners on website/app and text messages asking affected
of channels to notify those in need SMEs to reach out immediately to discuss options
• Implement reporting and MIS for program tracking • Daily tracking of all in-bound requests and approvals
• Build essential governance capabilities, relying on by channel, geography, and key client dimensions
straightforward nature of offer program • Systems parameterization and/or process adjustment
Operations to ensure adequate accounting of the program
• Implement system workarounds with compensating
controls where robust implementation is not feasible • Prepare training, Standard OperatingProcedure and other
• Utilize existing operational capacity without time to aids to coordinate personnel
further onboard or train new teams • Adapt contact center capacity plans; staff up specialized
teams to accept transfers from first-line agents
© Oliver Wyman 19IMMEDIATE RESPONSE: (II) FINANCIAL IMPACT SCENARIOS
In a context of fast-moving tectonic shifts (epidemiology, macroeconomy, public policy response) lenders should
know their ground and articulate the COVID-19 response narrative under the simulation of alternative scenarios
A. Covid-19 scenarios B. Covid-19 simulators C. Integrated results D. Covid-19 strategy
Alternative macro/public policy Bespoke real-time simulators help COVID-19 scenario results will be Feeding the fact-base into the “war
scenarios will be overlaid with articulate COVID-19 impacts and input integrated into a comprehensive room” for informed decision-making
possible bank response strategies into bank granular calculations scenario for crisis/recovery period
Exogenous scenarios Credit impacts Scenario results Board-level narrative
Macro-scenarios Corporates Profit & Loss
Recovery period
Epidemiology
Crisis period
SMEs Balance Sheet Strategy Investor
playbook notes
Retail Solvency
Macroeconomy
Main KPIs
Revenue impacts Scenario visualisation
Public policy response
Business volumes Granular calculation engines
Supervisors
Interest income/expense Volumes
Central Banks Fees & commissions NII
Fees & commissions
Governments/fiscal stimulus will support granular strategy
Other P&L (incl. costs)
Other impacts articulation in
Credit Risk
Business playbooks
Market Risk
Credit decisioning
Bank response Required Capital
Supervisory dialogue
Clients Funding Efficiency Capital Available Capital
Public advocacy
© Oliver Wyman 20IMMEDIATE RESPONSE: (II) FINANCIAL IMPACT SCENARIOS
Balance sheet dynamics (e.g. credit line usage, payment delays, funding flows) should be monitored real-time
and business response strategies articulated under constant involvement of front-line business and credit officers
Volume dynamics
I Business volume evolution II New business allocation
Initial credit impacts to be assessed on a run-off portfolio Projecting existing/new credit lines (with/out state guarantee)
Capital allocation
with state
for new business
guarantee
w/o state • New capital
guarantee allocation strategy
Corporate
– By client segment
– By client riskiness
– By product
• Direct health-check
Retail with business teams
As-is Defaults Forbearance Maturities Credit New Post-crisis Credit New New Total new (e.g. consumer)
B/S line max origination line max business business business • Alignment with
(regular) (guarantee)
Risk Appetite
Pricing dynamics
III Funding strategy
Assuming a new funding mix on the back of monetary policy
• Funding mix composition and
Retail
Retail Funding
planned issuances to be • Business developments require real-time monitoring
Funding reassessed in light of (e.g. credit line usage, late payments, retail deposit
Wholesale
– Latest monetary policy actions outflows) to feed scenario simulations
Funding – New rules regarding
Wholesale instrument eligibility • Involvement of front-line business and credit officers
Funding
– Market developments will ensure fast strategy implementation in day-to-day
Gov. funding
Gov. funding – Expected Retail and Wholesale business decisioning
funding behaviour
As-is plan Covid-19 scenario
© Oliver Wyman 21IMMEDIATE RESPONSE: (III) COVID-19 CREDIT PLAYBOOK
Urgent crisis decisioning should be carefully articulated and linked to medium-term business strategy, defining a crisis
response playbook, client-level financial support strategies and credit decisioning/triage
Credit playbook, with triage and treatment
• Once the immediate forbearance needs are addressed and the Segment Treatment objectives
financial scenarios (with and without publicly supporter lending)
are understood, begin working on a more refined COVID-19 Low risk clients Attract and develop
credit playbook able to manage the
Clients to be targeted with
crisis across
• The key is to triage and identify the clients that are able dedicated campaigns for retention/
scenarios
to sustain debt once crisis is over, if supplied with the relationship deepening
much-needed credit
Support and help to navigate
• Credit policies will need to be amended for the short-term,
within the restrictions understood via financial scenarios • Identify clients in temporary distress
Financially stable versus fundamental shift in risk profile
• To ensure quick disbursement of (publicly supported) lending in
clients pre crisis • Continue to engage frequently to make
an informed fashion, take the opportunity and managerial focus
and able to sustain aware of options and retain loyalty
to establish tactical, centrally controllable and quickly scalable
debt once it is over
credit processes • Provide continued forbearance or
• Keep working on the scenarios and re-assessing longer-term modifications based on
– Consider which downside risks may materialize if the crisis emerging scenario
persists, and the extent to which plans should be enacted Financially Support but limit exposure
– Similarly, consider where opportunities might exist to expand non- stable clients
and deepen relationships with clients (who can emerge strong before the crisis or • Continue to provide supportwhere not
from the crisis, unmet needs to be addressed) unable to sustain financially detrimental to bank
debt once the crisis • Limit growth in client-level exposure
is over
© Oliver Wyman 22IMMEDIATE RESPONSE: (III) COVID-19 CREDIT PLAYBOOK
The triage and sustainability assessment of potential borrowers must include the projection of the necessary liquidity
bridge to face the crisis – tactical bespoke tools for that can be built in ~3 weeks
Viable client Non-viable client
Liquidity Liquidity
HP of length and depth HP of length and depth
A of adverse cycle and PnL A of adverse cycle and PnL
B B
and BS stress and BS stress
Liquidity injection – Liquidity injection –
instalment loan instalment loan
B B
Liquidity need Liquidity need
for viability for viability
Liquidity post-financing Liquidity pre-financing
Cashflow Cashflow
C Cash flow post-crisis
sufficient to repay loan
C Cash flow unable to
repay the loan
Instalment
© Oliver Wyman 23IMMEDIATE RESPONSE: (IV) COORDINATED RELIEF EFFORT
Our work with banks shows that guarantees are challenging to use in practice for a number of reasons, so there needs
to be a coordinated effort between lenders and the government to ensure the added liquidity reaches the ones in need
Goals for stimulus package Observed challenges to achieve goals Coordinated relief effort
Lenders and government should act together to
Credit risk and NPLs operationalize stimulus package, lending based
Liquidity flowing to individuals and on aligned risk appetite and credit criteria to
SMEs overcoming banks’ • Lenders’ share of the guarantee is still dilute losses while maintaining financial
unwillingness to lend significant if high probability of default system’s stability
• Unclear credit criteria to apply to be eligible
1. Assess systemic risk and the size
between banks and government, leading to
of expected loss, jointly
banks fearing that guarantees could be
– Converge on likely scenarios
declined ex-post
– Run individual stress tests
• Banks are concerned of accumulating a large – Estimate systemic risk leveraging
Loans and direct aid reaching
NPL portfolio that will need to be worked out in individual stress testing capabilities
individuals and SMEs that are
the future (at an additional operational cost) – Aggregate results and segregate by
distressed and truly need it
Operational challenges segment and credit type
• Updating and aligning on credit underwriting 2. Agree on a risk appetite (“size of loss”) for
criteria and policies quickly segments and credit types under
stimulus/guarantee scheme
• Lack of updated information on prospects
3. Align credit underwriting and
Banks’ capital allocated most • High volume of loan applications resulting in renegotiation criteria to operationalize the
effectively while maintaining challenges in scaling up new high-volume agreed risk appetite for each
financial stability lending facilities on manual processes credit segment
Lack of information 4. Segregate portfolios within scope of
• Governments generally have little visibility on government guarantees for NPLs to be
ongoing lending volumes and flow worked out in the future
• Potential for misunderstanding re restrictions 5. Create direct data feed to monitor credit
Preventing the creation of a Retail flow (by segment, region, sector)
on eligible beneficiaries, requiring clear and
debt overhang not supportable
frequent communication from authorities
post-crisis
© Oliver Wyman 24MEDIUM-TERM STRATEGY
While regulators already announced a systemic impact analysis required to evaluate sector-wide solutions to the
impacts of the crisis, firms should be leveraging those as input to their longer term strategy responses
International regulators signalled the requirement to …and become a tool to support lenders’ strategic
use COVID scenario parameters within stress-testing decision making
Regulators have signalled the ambition to launch • Rapid repositioning of portfolio, according to
regulatory stress tests to assess systemic implications – Prevailing market conditions (volumes, pricing, etc.)
of the crisis – Usage of balance sheet, capital and funding
The Federal Reserve (FED) already • NPL Management
declared its desire to add COVID-19 as – Set limits for risk-taking, i.e. redistributing risks to
an essential new element to bank’s decrease vulnerability/increase resilience
stress tests1 • Strategic planning
– Planning/budgeting under stressed scenario
– Re-align performance management
European Banking Authority (EBA) – Risk Appetite restatement
has announced an EU-wide stress test, – Recovery planning/crisis playbook
in 20212
• Reprioritize initiatives
– Revisit strategic priorities/investments
– Balance defensive with offensive moves
However, lenders’ use of the exercise should go
– Identify acquisition/sale targets
beyond regulatory compliance….
1. The Wall Street Journal 10/04/2020; 2. EBA
© Oliver Wyman 25READ OUR LATEST INSIGHTS ABOUT COVID-19 AND ITS GLOBAL IMPACT ONLINE Oliver Wyman and our parent company Marsh & McLennan (MMC) have been monitoring the latest events and are putting forth our perspectives to support our clients and the industries they serve around the world. Our dedicated COVID-19 digital destination will be updated daily as the situation evolves. Visit our dedicated COVID-19 website © Oliver Wyman 26
APPENDIX DRILL-DOWNS ON CREDIT SUPPLY SHOCK AND GOVERNMENT STIMULUS PACKAGE
CREDIT SUPPLY SHOCK: CLIENT ACQUISITION
Surge in number of clients seeking credit favor large banks that serve as a “first stop shop” – and result in adverse
selection for other players
Volume of credit portfolio Client acquisition perspectives
• Due to their network and capillarity, large banks
Total 3,356 with deposit accounts have the main relationship
and are commonly the for potential borrowers
Leading “first stop shop”
banks 2,372
(S1) (71%)
• With the increase in demand and overall surge in
number of clients seeking credit, these players can
Medium select applicants with the best credit history and
and small 711 financial health first
banks (21%)
(S2 + S3) • Customers denied by large banks then turn to other
players, resulting in potential adverse selection
Financeiras 183
(S4) (5%) • Large banks also benefit from their extensive
customer bases, with data that achieved a critical
Credit mass to feed credit models such as financial,
80 demographic, behavioral, transactional
Union
(2%)
(S5) information, etc.
10
Instant Payments
(0.3%)
0 500 1,000 1,500 2,000 2,500 3,000 3,500
© Oliver Wyman 28CREDIT SUPPLY SHOCK: CREDIT DECISION
Given the change in customer profile, mix, and the new macroeconomic scenario, credit models and policies used
during “business as usual” are much less accurate in predicting credit performance
COVID-19 impacts on the credit decision
Decision engine
1 2 E
Auto
Risk appetite Credit policies accept
Manual
review
Decision
Risk
engine
Auto reject
3 4
Exposure
Data Credit model
Auto accept Manual review Auto reject
1 Potential changes in risk sensitivity arising from the crisis
2 Credit policies do not reflect new macroeconomic conditions
3 BAU historical data is not representative of behaviors during and after the crisis
4 Existing models are much less accurate in predicting credit performance given
• Lower overall capacity to pay vs. BAU
• Difficulties in separating willingness from capacity to pay in the historical data
© Oliver Wyman 29CREDIT SUPPLY SHOCK: FUNDING
Investor confidence goes down and shift capital to safer assets, increasing funding costs, with strong impact for fintechs
and smaller lenders who are Balance Sheet-constrained
Impact mapping of funding/capital raising traditional instruments
Use by large Use by smaller Identified movements
Instrument
banks institutions
Demand deposits • Decrease in compulsory deposits and LCR %
• Decrease in compulsory deposits and LCR %
• With SELIC’s decrease, the current portfolio is
affected by a
Term deposit
– Gain on post-fixed instruments
– Loss on pre-fixed instruments
• Investors demand higher return for new deposits
Investment via • Investors demand higher return for new deposits –
“FIDCs”/debt growth above 40% on March average carry spread1
• Decrease in capital buffer %
• Even though the majority of companies are taking
losses, the most significant ones are on smaller
Equity
FIs stocks2
– Itaú: -26.22%; Bradesco: -32.38%
– Banco Pan: -50.20%; Banco Pine: -52.94%
1. Data from Anbima on Mar 30th 2020; 2. Data from B3, difference between closing value on the day prior to the first COVID-19 case in Brazil (Feb 21st ) and closing value on March 30th
© Oliver Wyman 30CREDIT SUPPLY SHOCK: COLLECTIONS
Increase in delinquent volume is driven by constraints in the capacity to repay (rather than unwillingness to pay
from borrowers), making debt collection ineffective – in a moment where “hard” collection is not advised
Impact mapping of collection process
Worse collection performance due to deterioration of clients’ cash flow/income
Collection prior to default Credit policies
Stage Friendly Intensive collection External collection Judicial phase
Delinquency < 30 days past due < 90 days past due < 180 days past due < 360 days past due
Higher
volume of
credit on
default More borrowers with temporarily lower Operação em fase posterior dificultada
capacity to pay, plus the usual delinquency por medidas de supressão
Expectation to postpone payments and renegotiate, which is absolutely necessary during the crisis
but may generate reputational risk for the institution
© Oliver Wyman 31CREDIT SUPPLY SHOCK: CUSTOMER SERVICE
Strong, broad-service digital channels are even more necessary now, given unavailability/sanitary risks of brick-and-
mortar channels, associated with potential operational challenges to call centers
Map of channel adherence to demand type and projected impacts
Categories Agency ATM Customer service Online/Mobile Remote manager
Commercial activities
with non-clients
Commercial activities
with clients
Operational processes
related to sales
High value added services
Low value added services
Legend: Channel to be avoided Channel partially affected Low adherence High adherence
Lenders with a digital DNA will be less affected on the channels issue, besides being benefited by clients
already used to remote transactions
© Oliver Wyman 32GOVERNMENT STIMULUS: BRAZILIAN CENTRAL BANK INITIATIVES
The BCB is taking a series of measures with expected impact of BRL 1.2 TN (USD 240 BN), increasing the liquidity
available for banks to offer the required credit support to individuals and businesses
As of April 2nd2020
Area Measures
Micro- • Banks were authorized to re-negotiate terms of non-performing loans. Approximately BRL3.2 TN (~USD640 BN) in credit operations are eligible
prudential to benefit from the new conditions for debt renegotiations
Macro- • Reserve requirement ratio on time deposits was reduced from 31% to 25%. The reduction is expected to release liquidity of BRL50 BN
prudential & (USD10 BN). Additional reduction from 25% to 17%, with additional release of BRL68 BN (USD13.6 BN) as expected impact
financial • Regulation enhancement on liquidity coverage ratio (LCR). It is estimated that BRL86 BN (USD17 BN) of reserve requirements that previously
stability were not eligible as High Quality Liquid Assets (HQLA) will now be part of the banks’ HQLA
• Banks will be able to increase their funding to be guarantee by the FGC (Deposit Insurance Corporation). The expected impact is an expansion
of credit provision by approximately BRL200 BN
• Reduction of the factor applied to calculate the Capital Conservation buffer from 2.5% to 1.25% for one year. With a expected capital relief of
BRL56 BN (USD11.2 BN), this creates room for credit supply expansion of ~BRL640 BN (~USD128 BN)
• Allowing loans backed by Letras Financeiras guaranteed by credit operations – potential to unlock BRL670 BN (~USD134 BN) in credit
• Tax effects arising from the overhedging of investments in equity holding abroad will not be deducted from equity. The estimated impact is a
capital relief of BRL46 BN (USD9.2 BN), enabling ~BRL520 BN (USD104 BN) in expansion of credit
Capital
• Foster secondary market with loans backed by debentures. The expected impact is a potential increase of BRL91 BN (USD18.2 BN) in loans
markets
International • A US dollar liquidity arrangement (swap lines) was agreed with the US Federal Reserve to increase the supply of US dollars in the domestic
and in-country market, the provision amounts to USD60 BN and will remain in place for at least 6 months. Brazilian Real is down 21% against USD since
coordination Oct 2019
and input • First transactions in US dollars at interest rate 1% totaling USD3 BN were conducted on 20/03
• Central Bank established criteria for conducting repurchase operations in foreign currency, starting on 18/03. The eligible bonds to be
accepted as collateral are external federal public debt securities (Global Bonds), and a haircut of 10% will be applied over bonds’ market value.
The expected impact is a potential increase of BRL50 BN (USD10 BN) in liquidity
Monetary • Central Bank lowered interest rate (SELIC) by 50bps to 3.75%
policy • This is the 6th cut of interests rates in a row, from the starting level of 6.5% in August 2019
Source: Banco Central do Brasil (Link), (Link), (Link), Forbes (Link), ANBA (Link), Reuters (Link), BB, Caixa and BNDES
© Oliver Wyman 33Oliver Wyman is a global leader in management consulting that combines deep industry knowledge with specialized expertise in strategy,
operations, risk management, and organization transformation.
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Partner, Financial Services
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