COVID-19 Implications for Banks: the Case of An Emerging Economy

Abstract

The COVID-19 pandemic is damaging economies across the world including financial markets and institutions in all possible dimensions. Particularly for banks, the pandemic generates multifaceted crisis, mostly through increases in default rates. This is likely to be worse in developing economies with poor financial market architecture. As a case of emerging economies, this paper considers Bangladesh and examines the possible impacts of the pandemic on the country’s banking sector. Bangladesh’s banking sector already has a high level of non-performing loans (NPLs) and the pandemic is likely to worsen the situation. Using a state-designed stress testing model, the paper estimates the impacts of COVID-19 pandemic on three particular dimensions – firm value, capital adequacy, and interest income under different NPL shock scenarios. Findings suggest that all banks are likely to see a fall in risk-weighted asset values, capital adequacy ratio, and interest income at the individual bank and sectoral levels. However, estimates show that larger banks are relatively more vulnerable. The decline in all three dimensions will be disproportionately larger if NPL shocks become larger. Findings further show that a 10% NPL shock could force capital adequacy of all banks to go below the minimum BASEL-III requirement, while a 13% or more shock could turn it to zero or negative at the sectoral level. Findings call for an immediate and innovative policy measures to prevent a large-scale and contagious banking crisis in Bangladesh. The paper offers lessons for other developing and emerging economies similar to Bangladesh.