How could I ever repay You? HSBC to put aside £8.8bn to cover bad debts

May 28, 2020

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What's going on here?

HSBC will set aside a fund of £8.8bn to deal with the impact of the coronavirus crisis on its customers’ ability to repay debts.

What does this mean?

This will be its biggest provision for credit losses (debts a company is highly unlikely to recover) since the 2011 Eurozone debt crisis, when the bank took £9.69bn in loan loss provisions (an expense, set aside as an allowance for any uncollected debts) to survive.

HSBC is acting in response to increased risks that businesses in sectors like oil, gas and transport will struggle to pay off loans. With no end to the outbreak in sight, HSBC predicts higher credit losses than average in the months to come. It is also uncertain of the pandemic’s repercussions on other industries in the long-run, not to mention falling consumer activity levels and declining interest rates during this crisis. 

In response to this, the bank has taken a £2.4bn charge to help cover potential defaults (failure to pay debts) by customers on mortgages and credit card payments, because of the shrinking global economy. This measure caused HSBC’s profits to fall by 48% in the first quarter of 2020.

What's the big picture effect?

HSBC was not the first bank to adopt this course of action. Barclays forecasted a drop in the UK’s economic growth for 2020; citing loan defaults from consumers and companies as some of the key causes. In light of this, Barclays predicted it would need to set aside £4.5bn to cover bad debts for this year. Like HSBC, Barclays made an initial provision of £2.1bn to cover credit losses for the first 4 months of 2020 and, similarly, this brought about a fall in profits by 38%.

The absorption of bad debts, while necessary to survive an unforeseeable future, involves significant risk to HSBC and other banks alike. If HSBC is absorbing defaults that are equivalent to its shareholder equity, it may survive the crisis. However, global infections have reached a staggering 5.4m now and as the international economy slows down worldwide, writing off these loans would mean wiping out HSBC’s shareholder equity

It would lead to HSBC’s liabilities being greater than its assets, and if HSBC cannot fulfil obligations to consumers with deposits in their accounts, it will lead to insolvency or bank failure. This was the leading cause of the 2008 recession, where the collapse of international banks not only affected one economy, but that of other countries it did business with.

Bracing for a material drop in profits for 2020 and absorbing costs with loan loss provisions may help the banking industry survive, but only if they can ensure assets are kept on level with liabilities until an eventual economic turnaround.

Report written by Evania D’souza

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