The current health crisis has dramatic and profound effects on the world or financial markets but at the time of occurring was unexpected, hard-to-predict and generally speaking, not priced into our models of the world. The final condition to this black Swan event is that, once occurred, it is rationalised in hindsight as being capable of being expected.
In a markets context, the financial markets typically assume that the likelihood of something unexpected and catastrophic happening is so small as to be not worth worrying about, and certainly not priced into the market. The thing about rare and un-predictable catastrophic events is that they do eventually happen, certainly, in the space of a lifetime.
COVID-19 and Debt Markets
Though the current pandemic and the Global Financial Crises are two entirely different events, we should, at the very least, be disaster planning for events that resemble what happened in the Global Financial Crises. During the financial Crises, these included increasing defaults in banks’ portfolios, fear and panic in the retail spacewhich could culminate in a run on the banks placing pressure on bank liquidity and ultimately, issues of bank stability. However, the significant thing is that this is not a financial crisis at the moment and our banking sector is in extremely good shape.
Together with the banking sector, the Reserve Bank of New Zealand (RBNZ), has spent the last decade improving the capital ratios for locally incorporated banks, making our banks some of the most robust banks in the world. The RBNZ announced that it would delay the start date for the implementation of its tougher capital requirements for banks by 1 year, to 1 July 2021, and down the track “will consider whether further delays are necessary.” The RBNZ estimates that this delay will result in savings to the banks that could result in a further $47b in credit being available in the economy.
Corporate borrowers should first consider how reliant they are on ‘on demand’ overdrafts. The nature of an on demand overdraft is that it is available only at the lender’s discretion. In return, the borrower does not typically pay a commitment fee to the lender for its on-going availability. Perhaps not surprising, on demand overdrafts are prevalent in the SME business world. The alternative to an ‘on demand’ overdraft is a committed revolving line, a credit line where the lender is obliged to make funds available, subject to certain conditions precedent, and in return, you pay a fee to the lender. This small change could give far greater certainty to borrowers.
In the context of NZ, this is less pressing for most corporates, as most of the market is banked on a bilateral or club basis with a strong emphasis on the relationship and lenders can be expected to continue to help their customers. And the NZ banks are in great shape.