Now that it is clear the situation will not change much for at least another 6-9 months until mid-2021, the strategy is shifting.
Many lending clients who had 6 months relief are still unable to make monthly payments. And over 60% of corporate clients have not been able to recover sufficiently yet to make full monthly loan payments. Just like in other parts of the world, delinquency and defaults are quickly increasing on banks’ balance sheets.
Lessons from 2008-2011
The previous financial crisis of 2008-2011 has provided very useful data that can help us predict and prepare for certain scenario’s that financial institutions will face in 2021.
One of the insights is a direct correlation between expected delinquency and default rates in relation to unemployment. In general terms delinquency and subsequent default (write-offs) percentages tend to be half of the official unemployment rate once the economic effect has bottomed-out after 12-18 months. If unemployment for Aruba is expected to hover around 70% and Curaçao expected to reach its peak at 60% as some reports indicate, then our banks will face unprecedented 30%-35% problem loan ratios (normally 5-10%).
Banks are suffering
This means that banks will have to start creating more capital cushions, cancel dividend payouts and focus aggressively on cost management. The CBCS has already blocked dividend payouts for the years 2019 and 2020 in an effort to shore-up reserves. Dutch Caribbean banks traditionally make most money from large spreads on lending, complemented with transaction fees and relatively high commissions on other financial services. With the decimation of tourism and further economic slowdown, profitability for banks that complement their lending income by making money on transaction business is set to take a hit. Reduced net interest margins, reduced interchange fee income (cards) and fewer point-of-sale purchases across the board. At the same time, new mobile and e-wallet payment services, forced by stay-home measures due to Covid, are eating into the transaction pie.
More technology is the answer
Dutch Caribbean banks that have invested heavily in digitalization the past years will now enjoy the fruits of cost reduction by trimming-down staff without having an effect on products or service quality. In general the larger banks appear just ready to face the necessary staff reductions. Client facing technology such as e-services and mobile banking, or expanded ATM features aren’t the main culprits, although they reduce the need for many human relationship management services. In fact robotization, automatization, digitization, business intelligence systems and artificial intelligence are affecting many mid-office and back-office operations. Credit analysis, credit risk management, compliance controls, portfolio management, accounting, loan collections, loan and mortgage document digitization, reporting and alerts systems, employ many humans, but are all being automated. This wave hit Europe and the US about 10 years ago, and is coming hard in our region, further accelerated by Covid and an economic crisis.
It is expected that for Dutch Caribbean banks, at least a third of human jobs will disappear fast in 2020 and 2021. For employees who remain, compensation policies, common labor agreements and special employment benefits will be trimmed-back and in most cases simply disappear as employees will be faced with a choice of keeping their jobs, versus holding on to special perks and bonusses.
Unions will find limited sympathy from society and employers as well as little wiggle-room to get something extra for their members. The final unemployment impact of Covid-19 has not yet been reached. However, banks are already responding by shrinking staff significantly in Curaçao and Aruba. Because unions are infamously inflexible in these parts of the world, and will not cede on sobering their labor agreements, we can expect that financial sector employers will proceed with layoffs.
New employees, limited talent
To consolidate and face the challenges at financial institutions, new types of leadership and executives are required. Our region is vastly unprepared as traditionalist culture has held back true innovation leadership in finance. As a result surviving banks will face a talent gap and will have to import some foreign talent. The fact that many islands are offering special incentives for foreigners to set-up shop on a low-Covid island, will help financial institutions solve the talent problem. We must think of executives with experience and comfort in transparency across the board, or knowledge on rebuilding capital cushions or capital formation whilst facing falling revenues and profits.
Directors that are proven strong cost managers and know how to cap all company expenses whilst keeping service levels high. Credit leaders that are versed in tight lending policies. Not just filling checklists and requirements and then saying “no” to a loan. But with knowledge and creativity on loan models that lead to a “yes” for the customer.
Old-style credit staff and traditional scoring systems will require retraining, redesign or replacement. Strategic Executives with a longer term view, measurable through dashboards, who know how to stay the course, and keep refreshing the vision. Consolidation experts who know how to work the market and ensure the right “tie-ups”. Dutch Caribbean banks, used to the old-boys network where slow deliverables and average service quality standards were always “good enough”, will have to disrupt rapidly and put the mastodonts aside in order to survive.