Resilience in the face of crisis
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We view the potential for a systemic bank failure due to the coronavirus (COVID-19) economic shock as low. Today's banks are more resilient than in the past, given their robust capital positions and lower risk profile, not to mention supportive liquidity operations provided by central banks.

Banks stand out

While their valuations suggest the need for industry-wide dilutive capital raises, banks are broadly in good shape relative to other segments of the economy and their history.

Banks' strength

Equity capital is at post-World War II highs. Combined with de-risked and deleveraged balance sheets over the last decade, this implies that widespread bank insolvencies are less likely than in the past.

Bank stocks have come under intense pressure as investors contemplate the potential for meaningful credit losses on their balance sheets.

Markets tend to fixate on recent history, and we argue that there are many reasons to believe this period will resemble a 'typical' recessionary environment—not the global financial crisis (GFC) of 2008. Strong capital positions and supportive government actions bolstering liquidity have reduced the risk of systemic bank failures related to the COVID-19-induced shock. After examining how banks have fared in prior periods of economic decline, we believe that this time will not resemble the pattern of the GFC.

To examine what lessons we can draw, we surveyed global developed-market credit cycles going back to the Great Depression. This historical survey supports our view that in aggregate, the banking system today can sustain a once-in-a-century level of loan losses without the risk of meaningful dilution to equity owners. Importantly, however, this does not preclude individual banks from having credit issues requiring more capital.

Before digging into the data, it is useful to review some fundamental mechanics about how banks work, such as how credit events impact a bank's earnings and its balance sheet. In its simplest form, a bank gathers deposits and advances the money out to borrowers in the form of loans. The spread between the lending rate and the rate paid to depositors provides an earnings buffer to absorb any losses that may occur from a borrower's failure to repay. Banks are required to set up a reserve for loan losses and to maintain equity capital in case those losses exceed current earnings.

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