Recommendations for policy-makers based on industry practitioner perspectivesNew research from the World Economic Forum looks to identify emerging financial stability risks. Excerpts are presented here, drawn from the WEF April 2020 report, which can be accessed here.
This briefing is the outcome of several multi-stakeholder dialogues organized by the World Economic Forum’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 organizations, central banks 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 investment 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 financial market 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.
1. The global financial system has emerged from an initial period of extreme stress, in large part due to governments’ efforts to stimulate the economy, central banks’ speed at addressing market disruptions, and the resilience of financial institutions.
At the end of February 2020, financial markets entered a risk-off phase with significantly increased volatility across markets. Equity markets began declining rapidly, losing around 30% of market value in a matter of weeks, with the speed of the selloff exceeding that of the global financial crisis of 2008-2009 (GFC).
By early March, short-term funding markets and international US dollar funding markets started to show signs of stress and, in the weeks to follow, there were signs of illiquidity in the US Treasury market, the deepest and most liquid financial market in the world. These stresses carried through into credit markets, making it difficult for firms and governments to borrow funds at any tenure.
Central banks reacted quickly to the emerging signs of stress, applying lessons learned during the GFC. Participants from across the financial system noted that the US Federal Reserve and other central banks began addressing funding market impairment in a matter of days, as opposed to the months it took in some cases during the GFC. In doing so, they prevented stresses in underlying funding markets from propagating into market-wide disruptions. At the same time, central banks announced plans to expand asset purchase programs, with the goal of reintroducing liquidity into key asset classes, surprising some participants, who said they expected a more moderate central bank response.
2. While the initial acute phase of the financial crisis may have eased, firms and policy-makers remain concerned about a range of risks that could present a threat to financial stability and, ultimately, the economic recovery.
All stakeholders have repeatedly highlighted the degree of uncertainty currently plaguing financial markets and institutions. There is uncertainty about how badly the virus will affect different countries, how long containment measures must persist in different markets, how effective policy will be at mitigating lost activity, and how households and firms will change their behavior in the medium term.
While financial system resilience, fiscal support, regulatory flexibility and liquidity provision to date have helped ensure that the financial system is supportive of economic recovery, a more protracted slowdown may present new risks to the financial system. Thus, while the initial phase of the crisis has eased, participants are keenly aware that there may be greater turmoil affecting the financial system as the economic fallout continues, potentially precipitating a financial crisis down the line.
3. The economic and financial crisis in emerging market and developing economies may be more severe than in advanced economies.
Recommendations For Policy Makers
Both private-sector participants and policymakers remain concerned about the range of risks presented by weaknesses in many emerging market and developing countries. Most importantly, participants highlighted the risk of a true human tragedy if countries are unable to contain the spread and deadliness of COVID-19.
While these issues were not the focus of the discussions, participants from certain countries in sub-Saharan Africa, Latin America and South Asia spoke of economic conditions that could lead to the virus’s rapid spread (e.g. lack of access to clean water in some areas, limited infrastructure for remote working and population density), in addition to weak public health systems that are not equipped to manage the needs of the population in a pandemic.
“Flattening the curve” of firm mortality must be a top policy priority, and governments will have to expand the size and scope of support programs over time.
Most participants agreed that supporting SMEs and larger businesses is key to maintaining both employment and financial stability, and many have been encouraged by the speed with which advanced economies have rolled out support packages to firms. However, there is concern that the size of packages may prove insufficient for the duration of the crisis; that disbursement may be slower than is needed; that not all firms in need would be targeted; and that such programs may be overly reliant on debt financing.
To prevent short-term liquidity problems from becoming solvency issues, participants agreed, governments must remain vigilant about the availability of funds for SMEs and larger firms as the crisis persists. Moreover, given that SMEs have short windows of cash on hand, programs must be designed to ensure rapid disbursement of funds through simple, all-digital channels.