(Jernej Furman, CC BY 2.0)
One decade after the global financial crisis, the world is facing another crisis. And even though it seemed that the financial crisis which started in 2007 was already an Armageddon of sorts, the one we are currently facing will certainly have unprecedented consequences. The scale of the economic costs is likely be much greater. This view is shared, among others, by Kristalina Georgieva, the Managing Director of the International Monetary Fund (IMF). She believes that the coming crisis will be “much deeper” than the one with which we fought a decade ago. What’s more, the crisis from a decade ago primarily affected developed economies, while the current one is likely to hit the whole world. In contrast to the financial crisis, this time financial institutions are not the “flash point” of the crisis, although is not unlikely, that they will also feel its effects eventually.
This crisis initially affected a number of companies which ceased their normal activities, and in many cases went to the brink of bankruptcy, due to restrictions imposed in order to limit the further spread of the coronavirus. The problems faced by enterprises also result in deteriorating situation of millions of workers and households. Therefore, there is a risk that if the pandemic drags on, the crisis will spread to the whole economies, and its consequences will also be felt by financial institutions, including banks. The global financial safety net is also aware of the possibility of this scenario. For this reason, in light of the unprecedented nature of the situation, it has undertaken unprecedented actions.
What was included in the fiscal stimulus packages?
Due to the pandemic caused by the coronavirus, the governments of many countries across the world, on almost all continents, have adopted fiscal packages and have undertaken various actions to stimulate the economy. The world’s largest stimulus package, worth USD2 trillion, was launched in the United States. In Europe, the largest aid program for the economy, worth EUR750bn, was set up by Germany. Significant assistance packages were also launched by Greece (EUR450bn), Italy (EUR350bn), France (EUR345bn), Spain (EUR200bn), and the United Kingdom (GBP330bn).
The introduced fiscal packages vary not only in size, but also in the scope of provided assistance. However, most of these measures are primarily focused on providing support to micro, small and medium-sized enterprises, as well as self-employed persons, and on protecting jobs. We can distinguish four categories of measures taken.
Firstly, a number of governments have decided to postpone or suspend various types of tax or social burdens, i.e. tax payments (CIT, VAT) or compulsory social security contributions. In many countries, governments — in cooperation with banks — have also temporarily suspended mortgage and/or lease payments. Such actions are intended to improve liquidity of enterprises, as the above-mentioned burdens are not canceled, but only delayed.
Secondly, in order to support the short-term liquidity of companies, many countries have introduced guarantee schemes under which the government guarantees working capital facilities and investment loans for enterprises. Some countries have also offered preferential loans, which are usually granted through state-owned development banks.
Thirdly, financial support for enterprises also involves direct assistance in the form of grants, subsidies, or reimbursable advances.
Fourthly, some governments have decided to ease the burdens associated with wage payment to the employees who would qualify for layoffs due to business downtime caused by the pandemic. Such measures are intended to protect jobs and are introduced under the condition that employers retain their employees.
How are central banks maintaining liquidity?
Central banks also play an important role in anti-crisis actions. In the initial phase their measures were mainly intended to cut interest rates in order to lower the cost of financing and stimulate economic activity. The first central bank which decided to take such steps was the central bank of China. Outside of the Asia-Pacific region, interest rates were first cut by the central bank of the United States (The Federal Reserve System). The scale of interest rates cuts largely depended on the previously prevailing level of interest rates. As a side note, the single largest interest rate cut, implemented in Zimbabwe, amounted to as much as 1000 basis points. However, even after such a large interest rate cut, the country’s main interest rate remained at the high level of 25 per cent.
In developed countries, such as the members of the European Union, interest rates had remained at low levels for a long time, so the scale of interest rate cuts was naturally smaller. In the case of the Eurozone, the European Central Bank (ECB) did not lower the interest rates at all. At the same time, it’s worth noting that not all central banks decided to cut interest rates. In an attempt to strengthen the local currency the central bank of Denmark took opposite measures — it raised its key interest rate by 15 basis points (to minus 0.6 per cent).
Another type of action taken by central banks was reducing reserve requirements (pursued by 13 central banks) and increasing liquidity offered as part of repo operations, which were usually characterized by non-standard parameters, such as longer maturities (reaching up to 5 years, as in the case of the central bank of Croatia) or a wider range of accepted collateral (the Bank of Canada announced that it would accept any submitted collateral). Some central banks (such as the Bank of Thailand) allowed more institutions to participate in their operations. In addition to modified or additional repo operations, central banks have also launched additional repayable liquidity support programs (e.g. loan programs) going beyond the scope of standard monetary policy tools. These measures include, for example, the Term Funding Scheme with additional incentives for small and medium-sized enterprises announced by the Bank of England, the Primary Dealer Credit Facility and the Money Market Mutual Fund Facility announced by the Federal Reserve, or the COVID-19 refinancing facility announced by the Swiss National Bank.
The conditional liquidity support operations are also accompanied by the launch or the expansion of outright purchases of assets on the financial markets (quantitative easing, QE). When it comes to size, the largest programs of this sort include the increase in asset purchases announced by the Federal Reserve (USD500bn) and the Pandemic Emergency Purchase Program — the new asset purchase program announced by the ECB (EUR750bn). Both of these eventually evolved into unlimited, open-ended programs. However, central banks usually didn’t specify the ultimate scale of the planned asset purchases. The implemented QE programs mainly focus on interventions in the secondary markets for public and private securities. In some countries, such as Indonesia and the Philippines, the central banks were also allowed to intervene in the primary market for government bonds.
Central banks are active in the foreign exchange markets. The key form of intervention in FX markets was the launch of cooperation between the Federal Reserve and other central banks. This cooperation involved the establishment of swap lines aimed at easing the tensions in the USD-funding market. Some banks have also engaged in direct foreign exchange interventions in the domestic spot markets.
What measures are taken by supervisory authorities?
The measures taken by banking supervisory authorities are primarily aimed at ensuring that banks can use the previously built up capital and liquidity buffers and even can operate below these regulatory requirements, so that they can continue lending to the real economy, and especially to businesses. The goal is to ensure that the banks are able to maintain their functions associated with the financing of the real economy. For example, the ECB, acting in its supervisory capacity within the banking union, allowed banks to fully use their capital and liquidity buffers. This means that bank can operate below the capital requirements established by the supervisory authorities as part of the Pillar 2 Guidance, the capital conservation buffer, and below the requirements of the short-term liquidity coverage ratio (LCR). At the same time, however, the freed-up capital is to be used for lending to the economy, and not for the payment of dividends or bonuses. Recently, a number of supervisory bodies, including the European Banking Authority and the ECB, have issued a recommendation for banks not to pay out dividends or other forms of profit distribution.
Given the panic on the financial market caused by the coronavirus and the high volatility of shares’ prices, some supervisory bodies have also decided to introduce changes regarding short selling or to ban it altogether.
The main action taken in the context of macro-prudential policy was the immediate abolition or reduction of the countercyclical buffer (CCyB). Such decisions were taken in 12 countries. In nine the buffer was completely abolished, and in three other countries the CCyB rate was lowered to 1 per cent. Other macroprudential measures were less common. They involved the lowering or the abolition of requirements relating to additional structural capital buffers, such as the systemic risk buffer or buffers for systemically important institutions. It seems that such measures were adopted by countries which had not established countercyclical buffers before. The capital freed up as a result of the abolition of macro-prudential buffers can be used to maintain financing of the economy.
In conclusion, it should be mentioned that certain resolution authorities have also taken action to relax the Minimum Requirement for Own Funds and Eligible Liabilities (MREL), which also gives banks additional flexibility.
How are global institutions supporting the economy?
International institutions have also decided to introduce measures to support the economy. Among these initiatives measures of the following institutions should be highlighted:
- The World Bank — launched a support package in the amount of USD14bn in support to developing countries aimed at strengthening the local health care systems.
- The IMF — launched an assistance program in the amount of USD50bn to support low income countries and developing countries in combating the effects of the coronavirus epidemic.
- The European Investment Bank — declared the launch of financial assistance in the amount of EUR40bn for European companies, which have found themselves in a difficult position as a result of the pandemic. Furthermore, the Board of Directors of the European Investment Bank backed the creation of a EUR25bn guarantee fund to scale up its support to enterprises by an additional amount of up to EUR200bn.
- The EBRD — prepared a EUR1bn assistance program in support to enterprises tacking with the consequences of the coronavirus epidemic.
Generally, in contrast to the global financial crisis, the current rescue measures are aimed to maintain the operation of the enterprise sector. On the other hand, the main measures relating to banks are primarily aimed at ensuring that banks can use the previously built up capital and liquidity buffers and even can operate below these regulatory requirements to continue lending to the real economy, and especially to businesses.
In the event of a prolonged duration of the pandemic, the effects of the economic downturn will be felt by financial institutions, and in particular banks — mainly due to deteriorating quality of their assets. Given the above, it is possible that certain restructuring tools will have to be implemented. The creation of the so-called bad banks could prove particularly useful. Non-performing assets will also negatively affect banks’ capitalization levels. For this reason, we could see “second-round effects” of the crisis such as lenders’ solvency problems. This, in turn, would make it necessary to launch capital support programs for banks.
Anna Dobrzańska and Magdalena Kozińska (both PhD), work at the Financial Stability Department of Poland’s central bank, NBP.
The views expressed in this article are the private views of the authors and are not an expression of the official position of the NBP.