1. Introduction
The global health crisis associated with COVID-19 has been the most significant global disruption since the Second World War. The scale and scope of the global pandemic has demonstrated very clearly the health, economic, and financial risks associated with an increasingly interconnected world.
The Global Financial Crisis (GFC) of a decade earlier led to an increase in regional and global cooperation, including information sharing amongst national and international regulators. To date, the collaboration among regulators and central banks has ensured, in many countries, effective and timely responses to the unexpected and short-term financial challenges associated with the global health crisis.
The Basel III reforms on an international basis as well as many country-specific improvements in bank supervision and regulation made the banking industry more resilient to shocks, including the COVID-19 pandemic. National government interventions to support businesses and individuals through fiscal and monetary policies have contributed to the stability of the banking industry and minimised the economic impact of the pandemic on their core business in a number of countries. This improved resilience played an essential role in the industry's capacity to contribute constructively to the social and economic challenges associated with the COVID-19 pandemic.
It is noteworthy that the banking industry has acted as an enabler and contributed towards the solution of many of the challenges faced by governments, industries, markets, and individuals during the health crisis. The processes associated with cooperation and information sharing have continued and, in some instances, intensified during the COVID-19 pandemic, which will likely help with the remaining challenges of this crisis and may help ready the industry for the next global shock.
Banks’ liquidity risks have remained relatively low due to the ongoing quantitative easing and other measures introduced by central banks since the start of the COVID-19 pandemic. Whether banks remain resilient over time, particularly when some of the extraordinary fiscal and monetary support is gradually removed, remains to be seen.
It is not surprising that many nations have experienced significant increases in their debt to GDP ratios resulting from the government interventions to support their citizens and infrastructure in response to the global health crisis. These responses have mitigated, to some extent, the immediate impact of the pandemic on individuals and businesses in those nations.
However, whether the high debt/GDP ratios in some nations in the post-COVID-19 era will have the potential to generate shocks in the banking industry remains an issue to which the answer will become apparent over time.
2. Some observations about the effects of COVID-19 on banks and other financial institutions
COVID-19 has had and is likely to continue to have significant effects on banks and other financial institutions. For instance, the support systems associated with COVID-19 have involved huge government and central bank bond buybacks.
This is not only in the US, but also in Europe where corporate bond markets have been less accessible to smaller and more opaque firms. While in the US the impact on firms’ choices between bank loans and bonds may have a relatively small long-run effect, in Europe there seems to have been a major expansion of new smaller firms gaining access to the corporate bond market, leading to a notable growth of bond markets relative to bank loans.
In the recent periods of crisis, nonbank institutions or shadow banks have stepped in to offset any restrictions in bank lending. For example, hedge funds often take lead roles in syndicating debt. Recent research into these developments suggest that this substitution effect has been solidified by the global health crisis.
Almost paradoxically, the trend towards large banks dominating banking markets is likely to continue. For example, in the US the largest US banks are trading at record stock prices, and have significantly grown their asset bases to the $2 to $3 trillion dollar level, and have engaged in a wave of acquisitions of any financial firms seen as a threat. A good example is JP Morgan, with nearly $3 trillion in assets that has engaged in over 30 acquisitions of nonbank financial firms in the last year or so, from FinTech firms to retirement planning firms.
3. A brief overview of the research papers included in this special issue
The papers in this special issue have examined a number of themes associated with the banking system and the role of central banks and regulators during the COVID-19 pandemic. One paper introduces a new global database and policy classification framework that documents the global financial sector policy response to the COVID-19 pandemic across 154 jurisdictions. Other themes and issues in the context of COVID-19 covered in this Special Issue include the lending activities of banks around the world, bank lending in Europe, global syndicated lending, non-performing loans, the influence and effect of interventionalist policies implemented by the US Federal Reserve and the US Government- including on small business- and the role of liquidity in banking. The papers in this Special Issue are broadly categorized in the following four sub-sections.
3.1. The impact of COVID-19 on bank resilience, lending activities and stock markets around the world
In Brief: In their contribution to this special issue, Gönül Ҫolak and Özde Öztekin's paper entitled “The Impact of COVID-19 Pandemic on Bank Lending Around the World”, use broad cross-sectional data from 125 different countries and address two main questions:
They identify a number of questions such as what is the effect of the COVID-19 related global public health crisis on global bank lending patterns, and does it differ across countries? What roles do bank characteristics, health systems, regulatory and supervisory practices, bank market structure, credit and bond market development, and borrower heterogeneity play in shaping the banks’ reaction to the pandemic? The paper contributes to the growing literature on the pandemic economy by providing evidence about the strategic lending decisions made by banks when facing significant uncertainty and risk as they are being hit by the global pandemic. The empirical results suggest that COVID-19 shock was felt more severely by the banks located in countries other than those located in the U.S.
While most research studies on the global pandemic have focused on its economic effects, a few recent studies have also focused on the consequences of the global pandemic on the resilience of the banking system as a whole. The study by Yuejiao Duan, Sadok El Ghoul, Omrane Guedhami, Haoran Li, and Xinming Lia, entitled “Bank Systemic Risk around COVID-19: A Cross-Country Analysis” examines banks systemic risk. This study, across 64 countries, analyses the effect of the pandemic on bank systemic risk, for over 1500 listed banks. The authors find that the pandemic has increased systemic risk across all countries. The effect operates through government policy response and bank default risk channels. Their additional analysis suggests that the adverse effect on systemic stability is more pronounced for large, highly leveraged, riskier, high loan-to-asset, undercapitalized, and low network centrality banks. However, this effect is moderated by formal bank regulation (e.g., deposit insurance), ownership structure (e.g., foreign and government ownership), and informal institutions (e.g., culture and trust).
In investigating the impact of the COVID-19 crisis on the pricing of more than 4,000 syndicated loans granted by 77 lead lenders to 820 borrowers, the paper by Iftekhar Hasan, Panagiotis N. Politsidis and Zenu Sharma entitled “Global Syndicated Lending during the COVID-19 Pandemic” demonstrates that loan spreads rise by over 11 basis points in response to a one standard deviation increase the lender's exposure to COVID-19 and over 5 basis points for an equivalent increase in the borrower's exposure. The effect of the pandemic is exacerbated by government restrictions introduced to reduce the spread of the virus, and mitigated for relationship borrowers, borrowers listed in multiple exchanges or headquartered in countries that can attract institutional investors.
How European banks adjusted their lending at the onset of COVID-19 is examined in the paper by Özlem Dursun-de Neef and Alexander Schandlbauer entitled “COVID-19 and Zombie Lending of European Banks”. The authors demonstrate that local exposure to the COVID-19 outbreak and capitalization were the key influencing factors on these adjustments. The empirical results of this paper, using a bank-level COVID-19 exposure measure, indicate that higher exposure to COVID-19 led to a relative increase in worse-capitalized banks’ loans whereas their better-capitalized peers decreased their lending more. At the same time, better capitalized banks experienced a significantly larger increase in their delinquent and restructured loans. The authors state that their findings are in line with the zombie lending literature that banks with low capital have an incentive to issue more loans during contraction times to help their weaker borrowers so that they can avoid loan loss recognition and write-offs on their capital.
In order to investigate how different categories of crucial COVID-19 information influence price dynamics in stock and option markets, Kose John and Jingrui Li, in their paper entitled “COVID-19, Volatility Dynamics, and Sentiment Trading”, present a theoretical model in which behavioural traders make perceptual errors based on the intensity of sentiment arising from different types of news. Using Google search data, they are able to construct novel proxies for the sentiment levels induced by five categories of news, COVID, Market, Lockdown, Banking, and Government relief efforts. The empirical results show that the jump component in the VIX index is increasing significantly with COVID index, Market index, Lockdown index, and Banking index. However, only COVID index and Market index increase the jump component of realized volatility of the stock indices (S&P 500 index and S&P 500 Banks index).
3.2. The construction of new datasets to capture financial sector policy responses, including to the rise in NPLs, during COVID-19
As stated above, one of initiatives associated with COVID 19 was the building of a new dataset capable of capturing the financial sector policy response to the pandemic across many countries and over time. The paper by Erik Feyen, Tatiana Alonso Gispert, Tatsiana Kliatskova, and Davide S. Mare entitled “COVID-19 in Emerging Markets and Developing Economies”, has achieved this outcome by creating such a dataset for 154 jurisdictions. The paper documents that authorities around the world have introduced various measures to mitigate financial distress in the markets and for borrowers, and to support the provision of critical financial services to the real economy.
The empirical results of this study show that the policy makers in richer and more populous countries have been significantly more responsive and have taken more policy measures. Countries with higher private debt levels tend to respond earlier with banking sector and liquidity and funding measures.
As part of their contributions to understanding some of the dynamics of non-performing loans
(NPLs) during banking crises, it is fortuitous that research work by Anil Ari, Sophia Chen, and Lev Ratnovski entitled “The Dynamics of Non-Performing Loans during Banking Crises: A New Database with Post-COVID-19 Implications” has produced a new database for this purpose with Post-COVID-19 implications. The dataset of this study covers the yearly evolution of NPL-to-total loans ratios for 88 banking crises in 78 countries since 1990. This includes all major regional and global crises during this period (e.g., the Nordic banking crisis, the Asian financial crisis, the GFC) and numerous stand-alone crises in transition and low-income economies. These data allow the authors to study NPL dynamics during banking crises in a comprehensive manner. The study finds that most banking crises (81 percent) exhibit elevated NPLs that exceed 7 percent of total loans. In nearly half the crises, NPLs more than double compared to the precrisis period. The trajectory of NPLs typically follows an inverse U-shaped pattern.
In examining the impact of higher NPL ratios on the availability of bank credit among lenders and emerging market borrowers, the paper authored by Cyn-Young Park and Kwanho Shin entitled “ COVID-19, Non-performing Loans and Cross Border Bank Lending”, demonstrates that a rise in NPL ratios in both lender and borrower countries is positively associated with higher banking outflows from emerging market economies. The paper also reports that while a high share of US-dollar-denominated debt is generally positively associated with withdrawals of funds from emerging market borrowers, lenders are less responsive to a rise in NPL ratios in emerging market economies if their liabilities are denominated more in US dollars. A severe economic downturn brought on by the COVID-19 pandemic, combined with high debt levels globally, has the potential to result in mounting nonperforming loans (NPLs) in banking systems.
3.3. The impact of US Federal Reserve intervention policies on various sectors, including financial institutions, the bond market and small business operations
The declining number of community banks over the past few decades has raised concerns regarding their competitive viability in the face of changes in information technology, bank deregulation and bank production technologies. The viability of community banks is of particular concern if they, in fact, have a comparative advantage in lending to informationally opaque small businesses. In the paper by Christopher James, Jing Lu and Yangfan Sun, entitled “ Time Is Money: Real Effects of Relationship Lending in a Crisis” the authors provide evidence that small banks responded faster to the US Paycheck Protection Program (PPP) loan requests, and lent more intensively to small businesses, than larger banks. Using community bank pre-pandemic share of deposits/assets as an instrument for the intensity of PPP lending, they find a negative and significant relationship between county level bankruptcy filings and PPP lending per small business. Overall, their findings suggest that community banks remain an important conduit for small business credit, particularly during crises when a rapid response is required.
In order to find out whether there is a relationship between Federal Reserve intervention and systemic risk during the COVID-19 crisis, John Sedunov in his paper entitled “Federal Reserve Intervention and Systemic Risk during Financial Crises”, analyses the relationship between Federal Reserve emergency actions and aggregate U.S. systemic risk during the Global Financial Crisis (GFC) and the COVID-19 crisis. The author divides these actions into three categories: lender of last resort (LLR), liquidity provision, and open market operations (OMO). The Empirical results suggest that during the GFC, liquidity provision and open market operations (OMO) were related to reduced systemic risk, while evidence on lender of last resort (LLR) actions is mixed. The author does not find a relationship between Federal Reserve actions and systemic risk during the COVID-19 crisis. Together, these findings can inform actions and policy decisions in future financial crises.
In response to the COVID-19 crisis, the U.S. government passed the Coronavirus Aid, Relief, and Economic Security (CARES) Act on March 27, 2020, which created the Paycheck Protection Program (PPP) to aid small businesses and their employees. Most PPP loans were administered by commercial banks, and were completely forgivable by the government, posing no risks to the banks. Mustafa Karakaplan in his article entitled “ This Time is Really Different: The Multiplier Effect of the Paycheck Protection Program (PPP) on Small Business Bank Loans”, analyses whether the PPP loans had multiplier effects in generating additional small business portfolio loans by the PPP-issuing banks, for which the banks bore the risks. Using panel data, this study finds that each additional dollar of PPP credit significantly increased total conventional small business loans by between $0.78 and $1.29. The study also indicates that this multiplier effect may be understated to some extent as PPP generated positive economic externalities may have resulted in unmeasurable additional credits issued by non-PPP banks.
Using transaction data to analyse the reaction of corporate credit spreads to the Federal Reserve's monetary policy announcements during COVID-19, the paper by Yoshio Nozawa and Yancheng Qiu entitled “Corporate Bond Market Reactions to Quantitative Easing During the COVID-19 Pandemic” shows that bond markets are segmented across credit ratings, leading to different initial reactions across bonds with different credit ratings but spread across various sectors of corporate bonds over the longer event window. As part of quantifying the default risk channel of quantitative easing, the authors find that a significant fraction of credit spread changes correspond to the reduced default risk caused by the corporate bond purchase program.
In the final paper of this Special Issue, to analyse how public liquidity should be distributed to firms when immediate production entails externalities, Charles Kahn and Wolf Wagner in their paper entitled “Liquidity Provision During a Pandemic”, show that there is a trade-off between traditional lending (where liquidity is channelled through the banking system) and direct lending (by public authorities). Direct lending can be targeted according to the externalities, but will be less efficient in bringing liquidity to the highest quality firms. Which side of the trade-off an economy is on depends on the variability (but not the level) of externalities and productivities across firms. This has clear implications as to when direct lending should be favoured, and which segment of the economy benefits most from it.
4. Some potential future research directions
We believe that the papers in this Special Issue will inform policy makers, regulators, researchers and the business community about the impact of the Pandemic on financial institutions, including the banking industry, the bond market, financial liquidity and small business operations, in both the short and the long term. We are confident that the brief analysis and suggested future research themes discussed below will be useful for these industries and researchers as they seek to advance understanding and responses to the impact of COVID-19.
4.1. Lessons to be learnt from the different policies adopted in response to COVID-19 and their impact on bank lending, bank structure and real economies
One key area of future research is how different policy measures implemented across the world impacted bank lending decisions, the banks themselves, and real economic outcomes. While we note that there is already an active research agenda on these topics in the US, much more can be done across the world. Examining policy measures and bank-level data over time and across countries is likely to reveal many important lessons. Initial findings already suggest the impact of policy interventions adopted in different countries have been mixed, depending on bank and country characteristics. As more detailed bank-level data become available across the world, we can actually observe how banks behaved during the crisis; to what extent they lent to corporations and small firms and households; if banks with different characteristics – for example large versus small, or state-owned versus privately-owned – behaved differently and how these dynamics and their impact varied across different countries.
4.2. Could COVID-19 lead to bank runs in some countries?
While visible bank runs or market crashes have not been observed around the world, it is possible that banks in some countries, particularly those which were not well capitalized at the onset of the pandemic, may experience a deterioration of their asset quality, eventually leading to deleveraging and credit crunches that could slow down the economic recoveries in their nations. As fiscal pressures necessitate countries to reduce their fiscal and monetary support and wind down forbearance measures, these potential vulnerabilities will need to be carefully monitored.
4.3. How to respond to possible deterioration in asset quality
If deterioration of asset quality happens, identifying the best ways to repair this damage will be an important topic. For example, what market-based solutions will be available to deal with banks’ troubled assets? Are there circumstances where public intervention, whether targeted or broad, is needed to deal with nonperforming loans? Since insolvency frameworks are important to speed up the reduction of nonperforming loans, research providing guidance from successful debt restructuring schemes and insolvency reforms would be important.
4.4. The impact of COVID-19 on the real economy
Another related topic is the impact of bank lending during COVID-19 crisis on the real economy. As in the US, it will be important to investigate the experience of different countries to see if additional bank lending helped firms avoid closures and retain employment. Potential future questions could include: What was the experience after government support measures were discontinued? Did the timing and manner in which this winding down occurred determine the extent and impact of the resulting contraction?
4.5. Emerging changes to bank operations and business models in response to COVID-19
Another area of potential research could be to examine the impact of COVID-19 on longer-term structural issues. Under this broad area, whether the crisis has impacted bank operations and business models could be assessed. Some possible questions to be answered include: While digitalization and FinTech were significant trends that predate COVID-19, has the crisis accelerated these trends, given how prominent digital services became during the pandemic? Has the pandemic accelerated the trend away from brick-and-mortar banking and moved to on-line services? Could the growth of non-bank lending, particularly in the US, challenge bank hegemony over time? Will Europe continue to be viewed as a bank-dominated market in the future?
4.6. COVID-19’s impact on banking market structure
Another longer-term research question is whether and how the crisis will impact banking market structure. Even before COVID-19, there were significant research and policy discussions about how globalization and technological change have been leading to increasing levels of market power and concentration in the corporate sector. After the crisis, these worries have intensified, since failures of small firms and government support to larger corporations may have further increased market concentration, eroding competition in the real sector and hampering inclusive recovery. Similarly, the companion trends in the banking sector could be analysed. Will we see a more concentrated banking sector around the world after the crisis, consolidating power and reducing efficiency? Or since digital services and mobile banking gained so much traction during the crisis, will the banking industry face increased contestability due to competitive pressures from the big tech industry?
4.7. The impact of sustainable policies, including in response to climate change risk, for the banking industry
Finally, COVID-19 also reinforced the concerns around climate change as a way to increase resilience to future shocks, as well as reduce risks. There is now increasing recognition around the world that climate change is a global emergency, and that building green objectives into COVID-19 recovery packages is a priority. Importantly, sustainable policies also need to make economic sense, and financial institutions will be important in financing the investments required for green transition. Indeed, emerging research already suggests that credit constraints are an important barrier that may prevent corporations from reducing their carbon footprints. Central banks around the world are working on assessing climate risks, and financial institutions are already re-orienting investments towards green projects in anticipation of future green projects. Many banks have signed green pledges to reduce their lending to fossil-fuel-friendly industries and promote lending to new low-climate-risk energy firms. So far, there has not been convincing data that they have turned these words into actions, but all indications are that the secular pressures will increase. In the post-COVID world, impact and implications of these developments for the banking industry will be an interesting topic of future research.
Finally, the Guest Editors wish to sincerely thank all the Editors of the Journal of Banking and Finance, particularly Thorsten Beck, for his invaluable and insightful input and assistance throughout the process of refereeing, compiling and completing this Special Issue.
We also wish to thank the Institute of Global Finance at the University of New South Wales and the Asian Development Bank for their support of this Special Issue, including jointly organising special sessions as part of the 33rd Australasian Finance and Banking Conference at which some of the papers that are now included in this Special Issue were presented and discussed.