How a Pandemic Can Affect Credit Risk

In a follow-up to RMA’s Risk Readiness Webinar that addressed the operational risks presented by pandemics, Joe Breeden of Prescient Models recently addressed how pandemics can affect your financial institution’s portfolio.

Breeden shared his learning as a forecaster for a major lender in Hong Kong during the SARS crisis and found that it wasn’t the disease itself that caused economic stress and defaults, but the fear of the disease. Although new information about COVID-19 surfaces every day, global growth is currently exponential with confirmed cases tripling every week.

One lesson learned from SARS is the necessity to stress test for pandemics, particularly with COVID-19 since no one knows what will happen. Breeden recommended using stress test models from previous recessions and creating economic scenarios by looking at government and business responses to the fear of the disease, not the disease itself.

Breeden suggested that the onset of a recession will be sudden, not the more gradual slide that we have experienced with past recessions. However, the recovery will be quick once fear dissipates and pent-up demand drives a resurgence in the economy.

Breeden advised to watch out for a drop in retail sales, services, weekly hours worked, but not grocery purchases – this will signal a fall in the GDP. Next will come temporary store and factory closures and the failure of some small businesses, which will cause unemployment rates to rise. Also watch for neighborhoods that make headlines for outbreaks, subsequently local housing prices will fall.

Aside from the travel, entertainment, and sports industries being affected by the recession, the services industry, i.e. hair, nail, and other personal services will suffer. Banks with these industries in their portfolios – particularly senior living/assisted living facilities – need to follow up with borrowers – “know your customer” – to assess whether they have proper operational practices in place.

Purchase the recording of this webinar in addition to the February 11 webinar, Pandemic Planning: Crisis Management in the Framework of Operational Risk here.

Join us for upcoming offerings of the Risk Readiness Webinar Series.

 

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