IMF’s Global Financial Stability Review, April 2020: Markets in the Time of Covid-19

The IMF released yesterday the first chapter of its half-yearly Global Financial Stability Review (GFSR) for April 2020. The GFSR “provides an assessment of the global financial system and markets, and addresses emerging market financing in a global context. It focuses on current market conditions, highlighting systemic issues that could pose a risk to financial stability and sustained market access by emerging market borrowers. The Report draws out the financial ramifications of economic imbalances highlighted by the IMF’s World Economic Outlook.”

As the Review states, “While events are still unfolding, a further tightening in financial conditions may expose more “cracks” in the global financial system.”

Global financial conditions have tightened abruptly with the onset of the COVID-19 pandemic. The following are the highlights of the Review:

  • Risk asset prices have dropped sharply as investors have rushed for safety and liquidity resulting in a sharp market correction.
  • Stress in credit markets have been amplified by borrowers’ leverage and oil price collapse.
  • There have been strains in the risky credit market segments (high-yield bonds, leveraged loans, and private debt), dramatic widening of high-yield bondspreads especially in energy and sectors affected by the pandemic, sharp declines in leveraged loan prices, revision of ratings of speculative grade default forecasts from benign to recessionary levels.
  • Rising credit and liquidity risks resulted in deteriorating corporate credit marketsdeteriorated since late February on the back of rising credit and liquidity risks.
  • Pressures in short-term funding markets were exacerbated by dealers’ clogged balance sheets.
  • Financial deleveraging and strained market liquidity aggravated selling pressures
  • Emerging and frontier markets have experienced a record portfolio flow reversal.
  • Unwinding of stretched asset valuations exacerbated the sell-off and magnified the speed of asset price declines
  • An unprecedented combination of external shocks (COVID-19 pandemic, oil price decline, increased global risk aversion, and a prospect of global recession) led to a broad-based sell-off in emerging and frontier markets.
  • Portfolio flows to emerging markets have experienced a very sharp reversal. The breadth of outflowsin terms of the number of affected counties—was the largest
    since the global financial crisis.
  • A further tightening of financial conditions may expose financial vulnerabilities:
    • Asset managers may become distressed sellers, exacerbating asset price declines.
    • Leveraged firms may lose market access and defaults may spike.
  • Pressures on Asset Managers may lead to fire sales
  • Banks could act as an amplifier should the crisis deepen further
  • Banks’ resilience may be tested as economic and financial market stress rise.
  • Insurance companies may suffer losses
  • Prolonged external pressures will be a test for emerging and frontier

So, what has been done so far

  • Urgent  measures to address health concerns, to safeguard economic and financial stability and to prevent the emergence of adverse macrofinancial feedback loops
  • Timely, temporary, targeted fiscal measures, including additional support for health agencies, wage subsidies, cash payments to citizens, government-funded paid sick and family leaves, expanded unemployment benefits, and deferral of tax payments
  • Support firms and individuals facing payment difficulties through loan moratoria, restructuring of loan terms, or credit guarantees, expanded loan programs, including guarantees, for financing small- and medium-sized enterprises
  • To preserve the stability of the global financial system, central banks have been the first line of defence in leaning against the tightening in financial conditions.
  • Decisive monetary policy actions have been taken in three main areas:
    • First, central banks have significantly eased monetary policy by cutting policy rates by 50–150 basis points
    • Second, most central banks have provided additional liquidity to banking systems,
      including by lowering bank reserve requirements, easing collateral terms, upsizing
      liquidity repo operations, and extending the term of such operations, and funding support to banks.
    • Third, provision of US dollar liquidity through swap line arrangements to ameliorate tighter conditions in the global US dollar funding market.
  • Central bankers stepping in as buyers as last resort in several markets commercial paper, municipal bonds, asset-backed securities, as well as corporate debt to enhance the liquidity and functioning of short-term funding markets as well as to maintain the flow of credit to the broader economy.
  • To counter foreign currency funding pressures and mitigate damage to their economies from unprecedented capital flow reversals, foreign currency intervention programs to mitigate excessive volatility in their domestic currencies, reduced foreign currency reserve requirements or increased availability of foreign currency swaps and repos.
  • Bank regulatory/supervisory measures:
    • To allow banks to absorb losses and support the flow of credit to the economy, released macroprudential buffers (such as the countercyclical capital buffers, or domestic systemic risk buffers)
    • Issued supervisory expectations that capital and liquidity buffers included in the Basel III framework should be used (for example, enabling banks to operate below normal liquidity requirements and to use the capital conservation buffers).
    • Adjusted supervisory priorities and eased certain regulatory requirements, including delaying stress tests, introducing flexibility for banks in their treatment of nonperforming exposures or easing other requirements.
    • Restricting bank dividend payouts
  • Insurance sector measures
    • Regulatory actions to support business continuity and fair treatment of policyholders, for example by supporting a grace period on premium payment for the affected policyholders and allowing more flexibility on supervisory reporting.
    • Restrict dividend payments to ensure health of their capital position in balance with the protection of the insured.
    • Halted enforcement actions against affiliated parties’ purchases of assets from money market funds, temporarily permitted other open-end mutual funds to borrow from affiliated parties and related funds.
    • Extended deadlines for regulatory filings.
    • Short-sale bans to reduce the risk of downward price spirals and prevent further deterioration in liquidity conditions that could create systemic risk.
    • Circuit breakers triggered to halt trading temporarily to ensure orderly trading conditions. Also reparametrised their circuit breakers.

Where do we go now?

Monetary, fiscal, and financial sector policies will continue to be needed going forward.

Some constraints on policy options may emerge. Where policy rates are close to or below zero, asset purchases and forward guidance will be the main tools in the central banks’ monetary policy arsenal, but room may be reduced given already very low long-term rates.

Releasing countercyclical capital buffers and easing other macroprudential tools.

With limited fiscal space, some countries, challenging to provide credible fiscal backstop.

Extend the reach of central bank emergency facilities to all segments of financial markets.

If financial conditions deteriorate further, and credit downgrades and defaults rise meaningfully, further support to flow of credit.

Guiding principles for financial sector policies

Maintain balance between preserving financial stability, maintaining soundness of
financial institutions, and supporting economic activity:

Loan restructuring: renegotiate loan terms for companies and households struggling to service their debts, without lowering loan classification and provisioning standards.

Accounting treatment of credit losses: IFRS 9 Expected Credit Loss (ECL) requirements should not be applied mechanically and that forward-looking ECL estimates should be reasonable and supportable, taking into account expected nature of shock.

Banks: Use existing capital and liquidity buffers to absorb financial costs of customer loan restructuring and relieve pressures on banks’ funding and liquidity using full flexibility within existing regulatory frameworks.

Where impact is sizable and longer lasting and bank capital adequacy is affected, take targeted actions, including asking banks to submit credible capital restoration plans.

Provide fiscal support to banks’ clients – direct subsidies or tax relief – to help them repay their loans and finance their operations, or provide credit guarantees to banks. Transparent risk disclosure important for effective market discipline.

Discuss operational risks associated with COVID-19–related containment measures and business continuity plans with banks.

Insurance companies: Solvency frameworks allows for flexibility of regulatory actions in times of stress. Temporary regulatory accommodation may be necessary, but supervisors should not signal a lowering of standards. Insurers to prepare credible plans to ensure that they can maintain or restore solvency positions while providing insurance cover.

Ensure supervisory actions do not incentivise fire sale of assets.

Asset managers: Ensure that risk management frameworks are applied in a robust and effective manner. Support availability of wide set of liquidity management tools (gates/ deferred redemptions, swing pricing) and encourage fund managers to use them.

Provide clarity to fund managers on expectations, including circumstances in which use of liquidity management tools, including temporary suspension of redemptions, is appropriate.

Financial markets: For circuit breakers, volatility controls, and other market resilience measures to be effective, they need to be well calibrated, clearly defined, and appropriately communicated. When restricting certain activities, e.g., short selling, consider potential negative impact on liquidity and price discovery and ensure that they are needed to support market confidence and financial stability. Restrictions be temporary and within a predictable and reliable framework.

Liquidity provision by central banks: Central banks may intervene to prevent impairment in money, securities, and foreign exchange markets. The lending operations may involve short- and long-term repo operations (reverse repurchase agreements), discount window (possibly at longer maturities), and foreign exchange swaps. The outright asset purchases may include securities or foreign exchange. Expand range of eligible collateral (for both lending and outright operations) and counterparts beyond what is normally acceptable. Assess which markets are critical for financial stability, and ensure design of the program minimises moral hazard and risks to the central bank.

How should emerging and frontier markets address external pressures?

Emerging market and developing countries more vulnerable given dependence on external funding, increased leverage, and high reliance on commodity production.

Manage exchange rate pressures: For countries with adequate reserves, exchange rate intervention can lean against market illiquidity and thus play a role in muting excessive volatility. Interventions should not prevent necessary adjustments in exchange rate. Interventions should be planned on the basis that pressures arising from current crisis might last several months or longer. If macroprudential buffers exist, relaxation can reduce impact of current shock on market conditions and on overall economy. For example, foreign currency reserve requirements can be relaxed to mitigate foreign-exchange funding pressures.

Managing capital outflows: Capital flow management measures (CFMs) could be part of a broad policy package, but cannot substitute for warranted macroeconomic adjustment. Considerations to introduce CFMs need to have due regard to the country’s international obligations. CFMs generally need to be broad-based and effectively enforced to reduce capital outflows. Such measures should be implemented in a transparent manner, be temporary, and be lifted once crisis conditions abate.

Prepare for longer-term external funding disruptions: Have contingency plans for limited access to external funding markets for a prolonged period. Reducing rollover risks should take priority over concerns about containing costs when there are large downside risks from potential loss of market access. Cash buffers, and bilateral/multilateral assistance may be required. Countries facing fast deteriorating debt dynamics, limited market access, high external financing requirements, or high volatility, seek pre-emptive and cooperative debt resolution.

What should be the focus of international policy coordination?

Avoid price controls and ease trade restrictions on essential medical supplies. Bilateral and multilateral swap lines to broader range of emerging markets. Reduce broader capital flow disruptions. Continue efforts to bolster regulation of the financial system. Avoid rollback of regulation, or fragmentation through domestic actions that undermine international standards.

Watch out for release of remaining chapters on the IMF website (

© G Sreekumar 2021

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