The effects from the Covid-19 crisis come on top of the combination over the past decade of persistently low interest rates, regulatory changes, and competition from shadow banks and new digital entrants that challenged the traditional bank business model pre-Covid-19. The second report in the CEPR/IESE series on The Future of Banking tackles these crucial challenges, examining the competitive responses of the different players – both incumbents and new entrants – and the associated policy and regulatory issues. PDF Download The Covid-19 pandemic has induced a deep global economic crisis. Yet, in the middle of the financial turmoil over the past few months, banks were a source of resilience. Thanks
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The Covid-19 pandemic has induced a deep global economic crisis. Yet, in the middle of the financial turmoil over the past few months, banks were a source of resilience. Thanks to major reforms following the global financial crisis of 2007-2009, the much better capitalised and more liquid banks were not under immediate stress. In fact, banks are seen as useful to support the real sector’s financing needs. But they will come under stress. Large-scale insolvencies among firms may arise. A wave of bankruptcies among households may follow. Banks could get caught up eventually, with stresses to exceed those envisioned in many tests.
The effects from the crisis come on top of the combination over the past decade of persistently low interest rates, regulatory changes, and competition from shadow banks and new digital entrants that challenged the traditional bank business model pre-Covid-19. The report tackles these crucial challenges, examines the competitive responses of the different players – both incumbents and new entrants – and the associated policy and regulatory issues. It argues that:
- In the short run, banks may enjoy a revitalisation of relationship lending as they channel funds to customers over the crisis and enjoy the protection of the safety net and access to deposit financing.
- However, the Covid-19 crisis will accelerate pre-crisis tendencies as subdued growth and low interest rates will persist for a long time. It will test the resilience of the financial system, the regulatory reforms implemented after the global financial crisis, and the limits of central bank intervention.
- While banks may enjoy temporary regulatory and supervisory relief, digitalisation will receive a large impetus, with new entrants challenging banks. Digitalisation will increase the contestability of financial services, but its long-term impact will depend on the market structure that prevails. Banking may move from the traditional oligopoly to a system with a few dominant platforms that control access to a fragmented customer base, with a few BigTech firms and some platform-transformed incumbents monopolising the interface with customers.
- Medium-sized banks will suffer since they cannot manage the cost efficiencies and IT investment that are crucial in the new environment. Consolidation could be an escape route for stressed banks, but in the post-Covid-19 world, political obstacles to cross-border mergers may resurface as states become more protective of their national banking champions, with banks considered strategic.
- Regulators must adapt to digital disruption by balancing facilitating competition and allowing the benefits of innovation with protecting financial stability. In order to so, they must coordinate prudential regulation and competition policy with data policies, navigating complex trade-offs.