The deterioration of credit quality in the financial system as governments unwind the billions of dollars that have been pumped into the global economy in the wake of Covid-19 is the biggest risk facing the world post-pandemic.

This was the common concern of attendees as well as experts including bankers and central bankers at the Asian Financial Forum 2021, which was held for the first time in a completely digital format and attended by about 7,000 participants worldwide.

About 32% of the attendees cited credit risk and quality as the biggest challenge facing the banking industry in 2021. The second biggest risk, cited by 26.9% of the attendees, was cyber threats due to increasing digital banking transactions.

The main concern is that there will be a gradual deterioration in the overall credit quality standards on the part of financial institutions globally as they seek to lend out billions of dollars in economic relief designed to help the business sector survive through the economic challenges brought about by Covid-19.

There is also concern that sovereign institutions from the poorer emerging economies will be swamped with massive debts which they will be unable to pay, and this may lead to a widespread deterioration of the global economy.

Massive increase

“Many people speak of bubbles and this type of situation may create a big risk in the economy moving forward if we are not careful. All across the world the same measures have been taken in terms of a massive liquidity, low interest rates, and governments are fuelling increasing debt. The debt situation of many countries has seen a massive increase. It is sustainable today with a question mark on emerging economies. Most likely we will see over 2021 the need to support some emerging market economies,” says Jean Lemiere, chairman of BNP Paribas.

Martin Raiser, country director for China and Mongolia, and director for Korea of The World Bank, says: “For emerging markets, what happens to the yield curve, what happens to yields, particularly in the US, is important. We saw after the global financial crisis in 2013 the so-called taper tantrum. Clearly, emerging markets will need to be prepared for the possibility that rates move in the opposite direction, particularly given their elevated debt levels. On a structural level, I do think that there’s reason to believe that interest rates are likely to stay low for longer.”

Central bankers from Japan and Malaysia also warn of the possible deterioration of credit quality, although they note the strong and stable position of the financial industry at present.

“There is a need for policymakers to be very careful, as we proceed to normalization (in the financial system), we need to be careful that the various policy elements of monetary and regulatory policy should be well coordinated so that it doesn’t disrupt the market,” says Ryozo Himino, commissioner of the Financial Services Agency of Japan.

“One risk that comes to mind would the emergence credit losses over the course of this year as we gradually exit relief measures. We’re happy to note that the banks have been provisioning against high credit losses. That gives us some assurance that the banking sector will continue to be in good stead,” says Jessica Chew Cheng Lian, deputy governor of Bank Negara Malaysia.

There was minimal discussion on cyber threats to the financial system, but Lian says: “I think [there is] increasing reliance on financial technology, and this is not just new players, but also for traditional banks moving more and more of their activities onto digital platforms and the reliance on third-party service providers. The extent to which we have the line of sight from a supervisory point of view to the risk that may be building up outside the banking institutions themselves would be something that we’re very mindful and paying a lot of attention to.”