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Platform for Shaping the Future of Financial and Monetary Systems Impact of COVID-19 on the Global Recommendations for Policy-Makers Based on Industry Practitioner Perspectives

April 2020 Impact of COVID-19 on the

Background

This briefing is the outcome of several multistakeholder dialogues organized by the ’s Platform for Shaping the Future of Financial and Monetary Systems. Since mid-March, the Forum has virtually convened senior leaders from financial institutions, international , central and other institutions for several discussions about the impact of COVID-19 on the financial system.

These discussions aimed to identify emerging financial stability risks, understand adjustments to consumption and due to COVID-19, discuss where policy-maker attention is required, and share emergency measures implemented by firms as well as lessons learned from this crisis and earlier times of market stress.

This briefing summarizes the key findings of these discussions, providing insight into trends, private-sector views of government responses to date and priorities for future policy, areas of risk and uncertainty, and expectations for the future. While some context on market activity and policy decisions is provided, the focus is on sharing the views expressed by the participants in these Forum-hosted discussions, rather than a comprehensive overview of the situation.

The goal is to present the current state of debate among key financial system stakeholders. As the human and economic impacts of COVID-19 continue to be felt, the Forum will convene similar discussions and share this learning.

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Summary of policy recommendations

“Flattening the curve” of firm mortality must be a top policy priority, and governments will 1 have to expand the size and scope of support programmes over time.

Governments, including regulators and central banks, must continue to coordinate 2 policy on a global level to help maintain financial stability. Within countries, policy guidance must be clear and consistent across regulatory agencies.

Policy-makers must ensure that the financial system remains capable of safely meeting the 3 public’s need for through digital channels.

Advanced economies may need to further expand the support offered to emerging 4 markets and developing economies.

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Key insights

1. The global financial system has markets from propagating into market-wide emerged from an initial period of extreme disruptions. At the same time, central banks stress, in large part due to governments’ announced plans to expand asset purchase efforts to stimulate the economy, central programmes, with the goal of reintroducing banks’ speed at addressing into key asset classes, surprising disruptions, and the resilience of financial some participants, who said they expected institutions. a more moderate central response.

At the end of February 2020, financial In late March, equity markets began to markets entered a risk-off phase with rebound following announcements of significantly increased across substantial fiscal support packages by markets. Equity markets began declining large advanced economies. According to rapidly, losing around 30% of market value in market participants, this rebound reflects a matter of weeks, with the speed of the sell- expectations that the size and targeting of off exceeding that of the global the fiscal packages – averaging 10% of GDP of 2008-2009 (GFC). across the and Europe, with a focus on supporting small and By early March, short-term funding markets hard-hit industries – will effectively address the and international US dollar funding markets macroeconomic slowdown. started to show signs of stress and, in the weeks to follow, there were signs of illiquidity Moreover, throughout this period, equity in the US Treasury market, the deepest and market infrastructure remained remarkably most liquid financial market in the world. resilient, which, according to some These stresses carried through into participants, enabled markets to remain markets, making it difficult for firms and fully functional and begin to rebound. governments to borrow funds at any tenure. Exchanges utilized tools like market-wide circuit breakers, stock-specific guardrails Central banks reacted quickly to the and dynamic restrictions on short selling emerging signs of stress, applying lessons to maintain both orderly functioning and learned during the GFC. Participants market liquidity. Participants also noted from across the financial system noted that post- infrastructures remained that the US and other fully operational at record high volumes and central banks began addressing funding volatility, in addition to effectively managing market impairment in a matter of days, as margin requirements to prevent potential opposed to the months it took in some settlement failures from spilling over. cases during the GFC. In doing so, they prevented stresses in underlying funding

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In credit markets, the story has been 2. While the initial acute phase of the somewhat mixed to date, but participants financial crisis may have eased, firms and have been generally encouraged by the policy-makers remain concerned about a direction of developments. Whereas primary range of risks that could present a threat bond markets had effectively closed in early to financial stability and, ultimately, the March, by early April investment banks economic recovery. reported strong demand for new credit issuance by investment-grade borrowers. All stakeholders have repeatedly highlighted Participants attributed the re-opening of the degree of uncertainty currently plaguing primary credit markets to financial markets and institutions. There action as well as a somewhat improved is uncertainty about how badly the virus macroeconomic outlook. On the other hand, will affect different countries, how long high-yield markets and secondary bond containment measures must persist in markets remained largely closed, although different markets, how effective policy there is some optimism that new central will be at mitigating lost activity, and how bank corporate credit facilities could provide households and firms will change their a backstop in these markets. behaviour in the medium term.

Participants from the private sector and While financial system resilience, fiscal support, policy-makers agree that a key difference regulatory flexibility and liquidity provision to between the GFC and this crisis has been date have helped ensure that the financial the role of banks. Unlike the GFC, this crisis system is supportive of economic recovery, is fundamentally a public health emergency a more protracted slowdown may present that has become an economic downturn as new risks to the financial system. Thus, governments have taken measures to stop while the initial phase of the crisis has eased, the spread of the disease. But, rather than participants are keenly aware that there may contributing to the problem, banks are now a be greater turmoil affecting the financial system major part of the solution, due in large part to as the economic fallout continues, potentially the strength of their balance sheets. precipitating a financial crisis down the line.

The post-crisis regulatory framework has While equity markets have rebounded led to substantial increases in held somewhat since their March lows, these by large advanced economy banks, in rebounds may be premature, with market addition to more liquid assets and more valuations not reflecting potential extreme stable sources of funding. Not only are banks downside scenarios. Participants noted relatively stable, but they are also serving that volatility in equity prices likely reflects as the primary transmission mechanism for oscillation between more optimistic and much of the support components of pessimistic macroeconomic outlooks among many countries’ fiscal packages. Participants investors. However, some participants argued advocate that the focus of regulatory and that, even when equity markets reached their central bank policy should be on maintaining lowest levels in March, market valuations of this stability while enabling banks to meet the firms may not have priced in the most severe, needs of the real economy, which may be a yet plausible, downside scenarios. difficult balance to achieve.

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One view of such a scenario would involve high-yield credit markets – middle-market a severe protracted recession in advanced firms’ traditional source of capital and liquidity economies leading to a credit crunch – as – are largely closed due to crisis-driven risk banks face greater credit losses than their aversion. Given the scale of high-yield and balance sheets can withstand, despite leveraged loan markets globally, participants ongoing central bank support – which, in fear that failure to support these firms could turn, would deepen the recession. While lead to large balance sheet losses for both this scenario is not seen as likely, some banks and investors, in addition to additional participants said they believe that equity blows to employment and income. market investors should be more cognizant of downside risks. 3. The economic and financial crisis in and developing While investment grade borrowers have economies may be more severe than in begun issuing new bonds, secondary advanced economies. markets have remained largely closed. Asset managers have reported that it is difficult to Both private-sector participants and policy- find any price signals in the markets. Many makers remain concerned about the range participants argued that this illiquidity has of risks presented by weaknesses in many become a structural issue, as banks are no emerging market and developing countries. longer the primary market makers for much Most importantly, participants highlighted the of the fixed-income market, stemming from risk of a true human tragedy if countries are post-crisis regulatory changes. unable to contain the spread and deadliness of COVID-19. While it is too early to judge how effective the US Federal Reserve’s corporate credit While these issues were not the focus of purchasing programmes will be at easing the discussions, participants from certain illiquidity in these markets, there is concern countries in sub-Saharan Africa, Latin that persistent illiquidity could present a risk, America and South spoke of economic particularly in the event of forced sell-offs conditions that could lead to the virus’s rapid by asset owners or managers due to credit spread (e.g. lack of access to clean water in rating downgrades. Although there have some areas, limited infrastructure for remote been limited ratings downgrades to date, working and ), in addition a longer slowdown with limited additional to weak public health systems that are government support could push many not equipped to manage the needs of the firms’ debt profiles below investment grade, population in a pandemic. thereby requiring certain asset owners, such as pension funds, to offload bonds into an Participants are also vigilant about the illiquid market. financial and economic risks for emerging- market and developing economies, many A number of participants have argued of which face a multifaceted crisis unlike that middle-market firms in the hardest- those experienced in the 1990s or during hit sectors are the firms most at risk of the GFC. Factors include the massive insolvency, which could lead to significant decline in prices stemming from macroeconomic and financial fallout. a simultaneous supply-and-demand shock, Whereas many small businesses and large disruptions in supply chains, dramatically corporates have been targeted by a range of reduced exports given recessions in fiscal and central bank support programmes, advanced economies and, of course, the participants said they feel that mid-size firms need to implement COVID-19 containment have been largely excluded. Concurrently, measures domestically.

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Whereas most advanced economies are disbursing household support through addressing emerging recessions with large fintech platforms, and banks developing fiscal packages, many emerging-market with fintechs to rapidly and developing economies lack the fiscal transform their digital and contactless space to adequately respond. Moreover, offerings. since the beginning of the crisis, investors have fled from emerging markets, with However, in other countries, there is growing portfolio outflows exceeding those during concern that many fintech companies – the GFC and other periods of major stress. which have grown rapidly over the past decade by lending to SMEs and households While some emerging markets are better – could collapse under the stress of severe positioned to withstand and address credit losses. Given that in many countries these shocks, many are seeking various fintechs have helped expand access to forms of liquidity support from advanced financial services, participants felt that the economies. There has been record loss of fintech ecosystems in these countries demand for emergency programmes from could be a major blow to financial inclusion. the International Monetary Fund (IMF) and multilateral development banks, which these institutions have met by expanding the size and breadth of the support offered.

Some emerging market economies without access to bilateral swap lines with the US Federal Reserve have instead begun using the Fed’s new FIMA Repo Facility; participants representing banks from some of these countries said they are optimistic that this facility will effectively provide much-needed short-term US dollar liquidity.

Nevertheless, despite the increase in support to many countries, participants remain concerned that deep crises across emerging markets could prevent governments from being able to protect vulnerable populations, in addition to presenting significant losses to investors and lenders that could hurt balance sheets globally.

One area of uncertainty for emerging- market and developing countries is the future of (fintech) companies. In some countries, like China, fintech companies have been important in the policy and financial system response, with regulators allowing fintechs to digitally originate loans to SMEs, local governments

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Recommendations for policy-makers

1. “Flattening the curve” of firm Many participants said they feel the mortality must be a top policy experience of China – where banks, priority, and governments will have to fintechs and government worked hand- expand the size and scope of support in-hand to deliver emergency support to programmes over time. SMEs – is instructive. Many also felt that, as the economic crisis unfolds, it will be Most participants agreed that supporting necessary for the government to provide SMEs and larger businesses is key support to so-far-excluded companies, to maintaining both employment and such as middle-market firms lacking financial stability, and many have been access to capital markets. encouraged by the speed with which advanced economies have rolled out While most agreed that, in the short term, support packages to firms. However, the focus should be on liquidity support, there is concern that the size of packages there was also some consensus that, may prove insufficient for the duration ultimately, governments might need to take of the crisis; that disbursement may be equity in some firms in order to keep them slower than is needed; that not all firms afloat, which would require developing the in need would be targeted; and that such tools to fairly and efficiently do so. Some programmes may be overly reliant on debt participants highlighted the risk of adding financing. additional debt to firms, which, before the crisis, already had record levels of To prevent short-term liquidity problems borrowing. from becoming solvency issues, participants agreed, governments must Many participants said they feel that, as the remain vigilant about the availability of crisis develops from a “liquidity phase” into funds for SMEs and larger firms as the a “solvency phase”, it will be necessary crisis persists. Moreover, given that SMEs for governments to consider a range of have short windows of cash on hand, policy tools, including efficient bankruptcy programmes must be designed to ensure and restructuring systems, government rapid disbursement of funds through guarantees and other support for private simple, all-digital channels. , programmes for sector- specific government equity injections, and establishing asset companies.

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Given that many governments lack the firms, which often receive guidance from requisite expertise and structures for securities regulators. Policy-makers owning and operating businesses, they should ensure that regulatory and should build on domestic institutions supervisory changes are coordinated with relevant experience (e.g. sovereign across the relevant domestic institutions wealth funds), partner with the private to prevent confusion from limiting the sector where appropriate, and move effectiveness of policy action. early to design these programmes, with transparency and fairness in mind. 3. Policy-makers must ensure that the financial system remains capable 2. Governments, including regulators of safely meeting the public’s need and central banks, must continue to for financial services through digital coordinate policy on a global level to channels. help maintain financial stability. Within countries, policy guidance must be Given the need to quickly disburse clear and consistent across regulatory fiscal support to households and small agencies. businesses – in addition to the broader need to deliver financial services at Much as health experts have called for a time when populations are being governments to work together to contain asked to socially distance – financial the spread of COVID-19, participants institutions must have leading digital advocate deep coordination by financial capabilities. However, the crisis has sector policy-makers. Most agreed that so far exposed the variation in digital international cooperation to date has been maturity among institutions. While many meaningful, including through fora like the have rapidly adapted to digital operating Basel Committee and the Financial Stability models and met customers’ needs Board. However, many said they feel that, through digital channels, some banks given the speed with which the crisis lack the operational and customer- has evolved, small differences in policy facing capabilities to deliver in this new adjustments between countries could environment. place undue operational burden on firms. Thus, regulators, supervisors and central In the short term, policy-makers should banks should continue to coordinate leverage the strengths of the entire financial stability policy across countries, as financial system, including fintechs, to is appropriate. rapidly deliver support to small businesses and households. Moving forward, banks While participants agreed that regulatory can explore partnerships with fintechs policy within countries has generally to quickly and safely introduce new moved in the same direction, many products. Policy-makers should also expressed concern that, in certain areas, encourage banks to continue to explore regulators and supervisors are not other technologies and partnerships that sufficiently harmonized in their approach. enable them to better serve digital-first For example, with regard to calculating customers and to operate in a more agile expected credit losses under IFRS 9 fashion. regulations, some participants representing banks said they feel they are receiving mixed messages from prudential supervisors and from their accounting

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Participants also advocated quickly 4. Advanced economies may need updating regulations that restrict digital to further expand the support offered operations, citing the example of Chinese to emerging markets and developing regulators temporarily lifting certain economies. restrictions on fully digital lending. Regulators should use a risk-based Advanced economies have moved to increase approach to ensure that new AML/CFT their support to emerging markets and risks are not introduced. developing countries through both bilateral and multilateral channels; but, as the crisis in these Given increased reliance on e-commerce countries unfolds, additional assistance may and contactless payments, policy-makers be required. Participants agreed that advanced should continue to explore technologies that economy policy-makers, as well as investors enable fast, inexpensive, and ubiquitous and financial institutions, must continue to payments through a resilient payment develop and expand programmes to support system. Participants highlighted the these countries. challenge of ensuring inclusion, given the number of households that are unbanked or lack access to smartphones and other technologies. Some participants recommended stablecoins and blockchain- based central bank digital currencies as solutions with the potential to address key challenges, while others spoke of the need to improve the speed of existing payment networks.

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Next steps

The World Economic Forum’s Platform for Shaping the Future of Financial and Monetary Systems will continue to convene meetings of the Financial Services COVID-19 Response Network to discuss practitioners’ perspectives on emerging financial stability risks, the evolving public policy response and long-term challenges for the financial system.

If your institution is interested participating in these dialogues, please contact Matthew Blake ([email protected]).

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Acknowledgments

The World Economic Forum would like to thank the institutions participating in the Financial Services COVID-19 Response Network for their commitment and contributions to this multistakeholder dialogue, as well as members of the Platform for Shaping the Future of Financial and Monetary Systems who have participated in these discussions.

ABN AMRO Citi Organisation for Economic Absa Group CLS Bank International Co-operation and Development (OECD) Allianz SE Compagnie Financière Tradition Oliver Wyman AMTD Group CPP Investments PayPal Ant Financial Deloitte Ping An Technology (Shenzhen) Banco Santander SA European Commission Co. Ltd Bank for International EY RBC (Royal Bank of ) Settlements (BIS) Fidelity International Refinitiv Bank Julius Baer & Co. Ltd Fubon Financial Holding Co. Ltd S&P Global Bank Leumi Le-Israel BM HSBC Holdings Plc Salesforce Bank of America Industrial and Standard Chartered Bank of China Limited Suade Bank of Montreal ING Group SWIFT SCRL International Corporation Swiss Re Management Ltd BBVA SA International Monetary Fund (IMF) TD Bank Group BlackRock Inc. Invesco Ltd The Depository Trust & Clearing BlueOrange Capital Itaú Unibanco SA Corporation (DTCC) Bridgewater Associates LP JPMorgan Chase & Co. UBS AG China Construction Bank Lloyds Banking Group Plc UniCredit SpA China Reinsurance (Group) Mastercard Corporation Motive Partners University of Chicago China UnionPay Nasdaq Inc. Willis Towers Watson Circle Internet Financial Naspers Limited Insurance Group

We are grateful to our colleagues on the Platform team The views expressed in this briefing do not for their collaboration on this effort, including Mary necessarily represent the views of the World Emma Barton, Haleh Nazeri, Meagan Andrews, Derek Economic Forum nor those of its Members and Baraldi, Andre Belelieu, Kai Keller, and Drew Propson. Partners. This briefing is a contribution to the We are very thankful to Janet Hill for editing work, World Economic Forum’s insight and interaction Michela Dorbolò for graphic design and layout, and activities and is published to elicit comments and Madeleine Hillyer for guidance on messaging. further debate.

From the World Economic Forum

Matthew Blake, Head, Platform for Shaping the Future of Financial and Monetary Systems; Member of the Executive Committee Ben Weisman, Project Lead, Financial Innovation, Platform for Shaping the Future of Financial and Monetary Systems 12 The World Economic Forum, committed to improving the state of the world, is the International for Public-Private Cooperation.

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