The COVID-19 pandemic has fundamentally changed the way risks are defined in the financial markets.
A good example is the European Central Bank, which urged the banking sector to relax the definition of borrowers who are ‘unlikely to pay’ when it released 1.8 trillion Euros to support the EU’s economy. A significant risk for banks is supervisory punishment, well, the ECB just turned its back on classic definitions of high-risk borrowers, freeing up lenders to look at the market with fresh eyes.
The ECB also supports guarantees for banking losses, which appear inevitable at this point. Property sales and mortgages are likely to plummet, they already have in the UK, and in Cyprus there are reports of a sharp drop in property sales.
The about-turn at the ECB is largely due to Christine Lagarde’s progressive policies. Now head of the ECB, she is drawing on her experience at the International Monetary Fund, which is used to distressed lending.
Lagarde’s logic is that because the EU is based on a banking model, households and businesses will have to be funded through the banks.
For at least the medium term, lending will be based on extremely low interest rates and the definition of a viable borrower will be much wider.
For investors, this also has implications, because borrowing will be easier and cheaper than any time in modern economic history. Investors will have a role in helping worldwide economies recover, and it’s likely that commodities and stocks will reach historic lows before this is all over.
Worldwide, some well-known names are already in bankruptcy, starting with Neiman Marcus.
So, what is risk nowadays? Traditionally, banks like a safe bet, but safe bets may only return when a vaccine is found for COVID-19.
Meanwhile, financial risks are likely to be higher in labour-intensive sectors like factories, construction, the retail sector, travel companies, the tourism/hospitality sector and the public sector because COVID-19 remains a threat to large gatherings.
Risks are likely to be lower in small-to-medium companies, re-training, remote working technology, remote education technology, online information, large-scale digital technologies, online media and the agricultural sectors, which have much less person-to-person contact.
For the first time in my experience, the ECB is encouraging lending to freelancers, who typically never get taken seriously by banking institutions but who now represent the leanest and most flexible business activity there is.
Scaling down and scaling laterally appears to be the way of the future. Companies could reduce their financial risks by re-financing or restructuring their existing debt to take advantage of much lower interest rates. They could see what competencies and talents they have in-house that can be extended into a new business.
Now, more than ever, goodwill and supportive relationships between liquidity providers and borrowers will be the key to recovering in the best way possible - truly adapting and finding new ways to contribute to the economy.
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