Reopen And Recover

Changing Habits, Reshaping Business Models

Three focal-points emerge: Interest rates, digital processes & corporate and social behavior

New Market Research from Moody’s attempts to measure the impacts of COVID19 on the economy. Access the full report here.

For financial services, many of the coronavirus effects are expected to be short-term. But, Moody’s expects there will be far-reaching longer-term effects that will fundamentally reshape many aspects of the macroeconomy, business life and consumer behavior. The crisis has accelerated existing disruptive trends and is causing a rethink of conventional habits, potentially reshaping business models, consumer preferences and competitive dynamics. Moody’s sees three main enduring impacts for financial service providers.

  • Interest rates will remain severely depressed, eroding profitability
    Central banks will be compelled to maintain low or even negative interest rates for several more years and to drive governments to increase fiscal stimulus with uncertain long-term consequences and varying implications for banks and insurers, not least a profit squeeze. The impact of low rates will likely be greater in regions where we expect the yield curve to remain relatively flat coming out of the crisis, such as the euro area; and where recent declines in short-term rates have been larger.
  • Digital processes and services by both consumers and businesses will accelerate
    It is probable that customers who have newly converted to novel ways of working and shopping may not fully return to their old ways when restrictions are lifted. Likewise, financial services companies stand out as a key beneficiary of the work-at-home trend. Digital acceleration has also brought risks to incumbents. The convenience and universality of tech companies like Alphabet Inc.’s (Aa2 stable) Google unit and PayPal (A3 stable) for online business transactions or Venmo and Apple Pay for contactless payments will be hard for incumbents to replicate.
  • The crisis is increasing attention on corporate social behavior
    Regulations exist partly to balance the natural profit-seeking tendency of capitalistic institutions with the need to maintain financial stability and the wider social good. The balance between these two forces has shifted in favor of the latter since the global financial crisis, in response to the perception that the financial industry received an excessive share of economic rents. The shift is now likely to be reinforced in favor of the public good.

Many banks are offering mortgage and other loan relief, mostly but not solely in response to political pressure. They are expected to channel massive public funding toward both the corporate and household sector, with public authorities determining in part the credit criteria, pricing and management of these loans.

Insurers have been under strong pressure from certain governments and societies to pay coronavirus-related claims that are currently not covered by existing language, such as business interruption insurance. And they have also been asked to accept delays in premium payments without canceling coverage and provide other means of financial relief to their customers.

Asset managers are also acutely aware of the increased focus on ESG and clients’ scrutiny of their investment actions aligning with such considerations. The largest institutional investors and holders of equity, notably sovereign wealth funds and pensions, are increasingly seeking to incorporate broader ESG considerations and get utility from their assets beyond investment return.

Excerpts From Moody’s Report:

The coronavirus experience will likely change habits and reshape business models
The coronavirus pandemic and social distancing measures put in place to contain it are causing an unprecedented economic and psychological shock across the globe. The experience will be a defining event for many societal, business and credit trends.

For financial services, much of the impact will be short-term, but we expect there will be far-reaching longer-term effects that will fundamentally reshape many aspects of the macroeconomy, business life and consumer behavior. The crisis has accelerated existing disruptive trends and is causing a rethink of conventional habits, potentially reshaping business models, consumer preferences and competitive dynamics.

The crisis has accelerated existing disruptive trends and is causing a rethink of conventional habits, potentially reshaping business models, consumer preferences and competitive dynamics...

Identifying the long-lasting impact of this experience will be paramount for credit analysis. While many of the longer-term consequences are as yet unknown, we see three main areas where we can identify an enduring impact for financial service providers.

First, we expect the resulting global economic recession to compel central banks to maintain low or even negative interest rates for several more years and to drive governments to increase fiscal stimulus with uncertain long-term consequences and varying implications for banks and insurers, not least a profit squeeze.

Second, the outbreak will be a powerful catalyst for an accelerated migration to digital processes and services by both consumers and businesses. Third, the pandemic is accelerating a shift away from shareholder primacy towards addressing multiple stakeholders, such as clients, employees and the wider society, and driving an acceptance of a stronger social aspect to corporate strategy.

Interest rates will remain severely depressed, eroding profitability
The pandemic and government action to contain its spread have led to a severe contraction in economic activity, with many corporations experiencing near-complete declines in revenue, let alone profit. The deflationary effects of a reduction in aggregate demand coupled with the decline in oil prices will keep interest rates depressed for the near future, from already low levels before the crisis. Central banks have aggressively cut policy rates and implemented massive asset support programs, continuing to push investors and speculators toward riskier behavior in pursuit of returns.

The consequences for banks and other lenders are complex and will vary depending on their individual balance sheet structure. In addition to deteriorating asset quality, banks that predominantly finance their lending with customer deposits rather than borrowing on wholesale markets will see profitability eroded by persistently lower interest rates. This is because banks are generally reluctant to impose negative rates on their retail customers
in most jurisdictions, while market borrowings follow rates downward.

Spreads on bank lending will be also constrained by cheap government-funded credit, while for insurers, lower interest rates will drag down investment portfolio returns, which also encourages them to invest into riskier securities or more illiquid asset classes. The impact of low rates will likely be greater in regions where we expect the yield curve to remain relatively flat coming out of the crisis, such as the euro area; and where recent declines in short-term rates have been larger, notably the United States, where banks are also heavily deposit-funded.

The outbreak is causing a large-scale shift to digital services and a rethinking of old business habits, accelerating the transformation of business models and competitive dynamics
The trend toward conducting ever more commercial services digitally and remotely has been massively accelerated out of necessity as a result of health concerns and social restrictions. In short, the pandemic experience has ushered in a mass education on living life digitally.

Reluctant customers and businesses who may have been slower to embrace digital commerce, banking and payments have been forced to do so in short order. Companies that are unable to support such services have typically seen a shutdown in revenue. Additionally, the widespread implementation of remote work practices for many white-collar employees, and its success in many instances, may lead to a breakaway from traditional work habits. These changes will have profound and long-lasting effects on businesses regardless of how the current pandemic is resolved.

Within financial services, social distancing has created a surge in demand for online commerce, contactless payments and digital cash transfers. Financial institutions whose offerings lack digital functionality will either suffer more rapid franchise attrition as customers seek to replicate their needs elsewhere, or they will be forced to enhance their product offerings very quickly.

The sudden and extreme experience of the pandemic is proving to be a catalyst where old habits are suspended, allowing consumers to experience new digital ways of accomplishing trade and commerce. It is probable that customers who have newly converted to novel ways of working and shopping may not fully return to their old ways when restrictions are lifted, as a result of gains in functionality, user experience and utility. Likewise, service businesses that have been able to operate remotely during the pandemic will not completely shift back once they consider improvements in digital efficiencies and cost savings, not least in rent and business travel.