The fallout from COVID-19 continues to challenge and disrupt economies around the world, but the banking and capital markets sectors can help steady the ship. Through new, innovative liquidity plays, they can support small and medium enterprises (SMEs), struggling industries, and emerging markets to ensure that all sections of the global economy emerge successfully on the other side of this crisis.

Banks and capital markets firms need to play a leading role in the three distinct phases of this rescue effort – the sovereign phase, the debt phase, and the equity phase. Government support in many countries is likely to taper off this autumn, whereupon we will increasingly see economies transitioning into phases 2 (debt) and 3 (equity). During the debt phase, banks and fixed income investors will bear the primary burden of providing capital and liquidity. Whereas private investors and public capital will be the main players in the equity phase, when businesses, unable to service their debt, will need to be restructured and recapitalized.

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Financial institutions that participate in both phases 2 and 3 will need to think beyond short-term shareholder returns and take a “big picture” approach – finding opportunities that can benefit the wider economy while making smart, responsible bets for long-term growth.

Dealing with debt

During the debt phase, financial institutions will initially need to evaluate the landscape by reviewing their existing credit book to understand their levels of exposure across different sectors, and proactively identifying where new credit is needed.

As they begin to extend debt, they’ll need to spread their risk among different credit businesses while continuously checking for viability and assessing their credit capacity. They’ll need to set criteria to decide who should get relief and who needs to be restructured, which will prevent the rise of zombie corporations that are allowed to stagger on when it would be in the broader societal interest for them to default and restructure. This will require a delicate balancing act as financial institutions will need to identify the true strugglers, while still striving to be fair and equitable.

During the first phase of economic stabilization, the banking sector, in addition to offering standard debt vehicles, has largely acted as a conduit for the central banks’ guaranteed loan programmes for SMEs. However, bank lending has remained limp since the 2008 financial crisis as a result of uncertainty, regulation, and monetary policy, which means that they’re not the market’s panacea when it comes to smoothing the passage of loans, even if they’re backed by the government. That has provided an opening for the shadow banking industry – capital markets players, including private equity – to increase their direct private lending, either in the form of debt restructuring or bridge financing. In markets like the US, direct lending by institutional credit funds has become a powerful force in SME lending and in some recent time periods the majority of credit extended has come from these sources of capital.

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In phase 2, fewer loans will be backed by the government, so the industry has to walk the tightrope of balancing relief with financial responsibility. That will be especially true when it comes to dealing with struggling sectors. This is when Banking and Capital Markets players will need to be extra vigilant of economic indicators to constantly re-assess the depth of the crisis and their capacity to extend new debt to borrowers who are teetering on the edge of medium-term viability.

Roger Bieri, Head of Multinationals Clients at UBS, says: “The first thing that we focus on is trying to understand if a company is a designated survivor, i.e. has the company performed well before the crisis, and does it has a business model that is future-proof? If the answer is no, we help these companies, together with external advisors, to review their business model and potentially restructure the business and/or find new investors."