## CHAPTER 1 GLOBAL FINANCIAL STABILITY OVERVIEW: MARKETS IN THE TIME OF COVID-19

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### Key developments
- Global financial conditions tightened abruptly with the onset of the COVID-19 pandemic.
- Risk asset prices dropped sharply as investors rushed for safety and liquidity.
- Emerging and frontier markets experienced a record portfolio flow reversal.
- 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.
- Banks’ resilience may be tested as economic and financial market stress rise.
- Strong policy response and international cooperation are needed to tackle these challenges.

### Government bond markets and monetary policy
- Market-implied probability of inflation falling below 1 percent in any single year over the next five years spiked in Europe and in the United States.
- Policy rates in several advanced economies came down close to zero as central banks responded with decisive monetary policy easing.
- The stock of government bonds with yields of less than 1 percent doubled from about 40 percent of bonds outstanding at the end of 2019 to about 80 percent in March.
- Treasury yields fell sharply, and government bond yields are now expected to stay low for even longer.

### Corporate credit markets and borrower leverage
- Conditions in corporate credit markets deteriorated sharply since late February on rising credit and liquidity risks.
- Investment grade bond spreads widened as investors focused on the large share of BBB credits at risk of downgrades and elevated leverage in this market segment.
- Global risky credit market segments—high-yield bonds, leveraged loans, and private debt—had expanded rapidly after the global financial crisis, reaching $9 trillion globally, while borrowers’ credit quality, underwriting standards, and investor protections weakened.
- High-yield bond spreads widened dramatically, particularly for energy firms and sectors most affected by the pandemic, such as transportation.
- Leveraged loan prices experienced a decline of about half the drop seen during the global financial crisis at the worst point of the March sell-off.
- Rating agencies revised up their speculative-grade default forecasts from benign to recessionary levels; market-implied US high-yield defaults rose to 8–10 percent.
- Global issuance of high-yield bonds came to a halt and issuance of leveraged loans fell considerably.
- Following central bank steps (including extending emergency facilities to corporate debt and to collateralized loan obligation vehicles), spreads began to narrow in some risky credit segments.

### Short-term funding and US dollar funding markets
- The US commercial paper market froze as prime money market funds reduced commercial paper holdings to raise cash and dealer banks faced balance sheet constraints and risk limits, causing commercial paper spreads to widen dramatically.
- Short-term funding markets in Australia, Canada, and the United Kingdom experienced similar pressures.
- Conditions in global US dollar funding markets tightened: the spread between LIBOR and a risk-free rate widened sharply and the cross-currency basis widened for most currencies.
- Initial tightening in funding conditions was more severe in economies with large dollar funding demand but with no swap lines with the US Federal Reserve.
- Several central banks agreed to augment US dollar liquidity through enhancements to existing swap lines or new temporary swap lines; since the end of March, pressures in global US dollar funding markets appeared to have abated somewhat.

### Market liquidity, deleveraging, and dealers’ balance sheets
- Financial deleveraging and strained market liquidity aggravated selling pressures: leveraged investors were forced to close positions to meet margin calls or rebalance portfolios, amplifying asset price declines.
- Volatility-targeting investors and those running basis trades in US Treasuries were forced to unwind positions, increasing dealers’ holdings of Treasury bonds and straining dealers’ ability to intermediate markets.
- The two-fold increase in the balances of central counterparty clearing houses with the US Federal Reserve in only two weeks is evidence that leveraged investors faced significant margin calls.
- Liquidity conditions in the US Treasury market deteriorated sharply; high-frequency jump analysis indicates liquidity conditions worsened meaningfully since end-February.
- In response, the US Federal Reserve increased the scale of asset purchases, introduced additional large open-market operations, allowed foreign central banks to repo their Treasury holdings in exchange for dollars, and temporarily excluded US Treasury securities and reserves from the calculation of the supplementary leverage ratio for bank holding companies.

### Stretched asset valuations and equity market dynamics
- Prior to the COVID-19 sell-off, price-earnings ratios in equity markets had reached the highest levels since the global financial crisis; equity valuations had become increasingly stretched since the October 2019 GFSR.
- After the COVID-19 outbreak, equity prices fell sharply through mid-March, wiping out a significant portion of overvaluation in many markets and sectors.
- The US equity market was a notable exception: the decline in prices in March was outpaced by a sharp deterioration in fundamentals-based value, increasing the extent of positive misalignment.
- Dispersion in earnings forecasts spiked to historically high levels—about two times the level seen in the global financial crisis—contributing to a large reduction in fundamentals-based value.
- Estimates of S&P 500 EPS growth in 2020 by analysts at major investment banks range from −8 percent to −33 percent.
- Downward revisions in earnings-per-share (EPS) growth forecasts have been material in many markets, but as of early April likely do not fully reflect the expected deterioration of corporate earnings outlook.

### Emerging and frontier markets, portfolio flows, and exchange rates
- 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.
- Emerging market equity prices have fallen by about 20 percent, on net, since mid-January.
- Currencies of commodity-producing economies (Brazil, Colombia, Mexico, Russia, and South Africa) tumbled by more than 20 percent against the US dollar in the first quarter of 2020.
- Spreads of dollar-denominated emerging market sovereign bonds rose to nearly 700 basis points by the end of March—the highest level since the global financial crisis—although they narrowed somewhat in recent weeks.
- The number of distressed sovereign issuers (those with spreads over 1,000 basis points) rose to record levels.
- Nonresident portfolio outflows from emerging markets reached a record level in dollar terms (more than $100 billion since January 21) and the highest ever relative to their aggregate GDP in the first quarter of 2020.
- South Africa and Thailand witnessed outflows of more than 1   percent of GDP in just two months.
- Retail outflows surged, while institutional investors also reduced positions because of redemptions or risk limits.
- Authorities responded with currency interventions, liquidity support to bond markets and the banking system, and efforts to establish swap lines with the US Federal Reserve and the European Central Bank.

### Global financial conditions, growth outlook, and scenario risk
- Global financial conditions had been easing through 2019 and early 2020 but tightened sharply in March 2020; the 2020:Q1 FCI values are based on the March 2020 average.
- Tightening was pronounced and unprecedented in speed, even compared to the global financial crisis.
- Tightening was driven largely by a very significant deterioration in corporate valuations, with falling equity prices and widening corporate spreads only marginally offset by declines in interest rates.
- China’s financial conditions remained broadly stable relative to others, reflecting limited external financial linkages, a strong role of government-owned financial institutions and firms, and early proactive policy actions.
- The 2020 global growth forecast was revised from 3.3 percent (January 2020 WEO Update) to −3   percent (April 2020 WEO).
- One-year-ahead forecast distribution as of March 2020 indicates a 5 percent probability that global growth could fall below −7.4 percent.
- The odds of global growth exceeding zero in 2020 are close to only 4 percent.
- Near-term growth-at-risk metric is approaching levels last seen during the global financial crisis.
- Scenario risk: in the most severe WEO scenario (longer-than-expected containment in 2020 and a second outbreak in 2021), global output would continue to fall throughout 2020 and 2021 and would be almost 8 percent below baseline in 2021.
- A further tightening of financial conditions could limit policy space, weaken investor sentiment, and make it challenging for emerging and frontier markets to contain destabilizing effects of portfolio flow reversals.

### Financial vulnerabilities: banks, asset managers, insurers, and corporates
- Preexisting vulnerabilities:
  - Vulnerabilities are elevated in the corporate and sovereign sectors as global nonfinancial sector debt has reached new highs.
  - Asset managers entered the COVID-19 crisis with higher leverage, maturity, and liquidity mismatches in several countries (notably, China and the United States).
  - Bank vulnerabilities are moderate overall, though vulnerabilities continue to be high in China and have increased in other emerging market economies and the euro area.
  - Insurance-sector vulnerabilities are less pronounced in aggregate but remain high in some countries and regions.
- Asset managers:
  - Cash buffers are estimated at about 7 percent of assets for an average open-end fixed income fund.
  - Outflows could exhaust cash buffers and force the sale of high-quality liquid assets or less-liquid assets, reinforcing price declines across markets.
  - So far, very few suspensions of investor redemptions occurred; in the United Kingdom several property funds were gated, and some smaller European bond funds were reportedly suspended with most suspensions lifted within days.
- Banks:
  - Average Tier 1 capital ratios across economies with large financial systems are more than 400 basis points higher than they were at the end of 2007.
  - Total undrawn lines of credit amounted to $10 trillion at the end of 2019 for a sample of almost 400 banks headquartered in G7 economies—some 50 percent of risk-weighted assets.
  - Banks are holding more liquid assets and have benefited from substantial and coordinated central bank action to provide liquidity.
  - Bank equity prices fell by about 35 percent, on average, since mid-January and by up to 60 percent in some countries.
  - If market valuations are used to calculate capital ratios, many banks would appear to have weak capitalization—similar to levels during the global financial crisis; median market-adjusted capitalization is now higher than in 2008 only in the United States.
- Insurers:
  - Shares of insurers in major jurisdictions were hit hard, with most experiencing declines of more than 30 percent before partially reversing losses in late March to early April.
  - US insurers are estimated to have over $40 billion of BBB credits at risk of downgrade to sub-investment grade; this $40 billion is less than 2 percent of their corporate bond investments.
  - The estimated year-to-date performance illustrations use broad aggregate exposure data as of Q3 2019 and proxy indices (Bloomberg Barclays, Euro Stoxx 50, S&P 500).

### Policy response: central bank facilities and fiscal/financial measures
- Central bank emergency facilities and purchases:
  - Bank of Canada: Bankers’ Acceptance Purchase Facility; Provincial Money Market Purchase Program; Commercial Paper Purchase Program.
  - Bank of England: Asset Purchase Facility—£200 billion increase to a total of £645 billion; COVID-19 Corporate Financing Facility.
  - Bank of Japan: temporary outright purchases of commercial paper and corporate bonds; funds-supplying operations against pooled collateral; expansion of Securities Lending Facility; doubling of ETF purchases.
  - European Central Bank: Pandemic Emergency Purchase Program up to EUR 750 billion; Expanded ECB Asset Purchase Program additional EUR 120 billion.
  - US Federal Reserve: Primary Dealer Credit Facility; Commercial Paper Funding Facility; Money Market Mutual Fund Facility; Primary Market Corporate Credit Facility; Secondary Market Corporate Credit Facility; Term Asset-Backed Securities Loan Facility; Municipal Liquidity Facility.
- Regulatory and supervisory measures:
  - Release of macroprudential buffers and supervisory expectations to use Basel III capital and liquidity buffers.
  - Temporary adjustments to supervisory priorities and easing of certain regulatory requirements, including delaying stress tests and introducing flexibility for banks in their treatment of nonperforming exposures.
  - Some supervisors recommended restricting bank dividend payouts.
  - Insurance supervisors: grace periods on premium payments and flexibility on supervisory reporting; some National Competent Authorities have gone beyond Solvency II measures.
  - Asset manager support: US SEC halted enforcement actions against affiliated parties’ purchases of assets from money market funds and temporarily permitted other open-end mutual funds to borrow from affiliated parties and related funds.
  - Market interventions: short-sale bans and reparametrized circuit breakers in many countries.
- Effectiveness and constraints:
  - Effectiveness of policies remains difficult to fully assess while events are unfolding; market sentiment showed signs of improvement and risk asset prices retraced through early April some of their earlier declines.
  - Key constraints include policy rates in most advanced economies now close to or below zero, limited ability to release countercyclical capital buffers (only about a third of systemically important jurisdictions had the option of releasing them before the virus outbreak), and limited fiscal space in some countries.

### Guiding principles and supervisory recommendations
- Loan restructuring:
  - Encourage banks to prudently renegotiate loan terms without lowering loan classification and provisioning standards.
  - Banks should assess customers’ creditworthiness on an ongoing basis and update assessments promptly.
- Accounting treatment of credit losses:
  - Clarify IFRS 9 ECL application: forward-looking ECL estimates should be reasonable and supportable, reflecting temporary nature of the shock, economic support measures, and scarcity of reliable information.
- Banks:
  - Use existing capital and liquidity buffers; supervisors should consider targeted actions if impacts are sizable and longer lasting, including capital restoration plans and possible fiscal support or credit guarantees.
  - Emphasize transparent risk disclosure and supervisory expectations; address operational risks and business continuity plans.
- Insurance companies:
  - Use ladder of supervisory intervention to allow flexibility in extreme stress while not signaling a lowering of standards.
  - Require insurers to prepare credible plans to maintain or restore solvency and consider macroprudential implications to avoid incentivizing asset fire sales.
- Asset managers:
  - Ensure robust risk management and support liquidity management tools (gates/deferred redemptions, swing pricing); encourage full use where in unitholders’ interests.
  - Monitor valuation challenges and provide clarity on expectations for temporary suspension of redemptions.
- Market resilience:
  - Circuit breakers, volatility controls, and other measures must be well calibrated, clearly defined, and appropriately communicated.
  - Temporary restrictions (including short-selling bans) should be temporary, predictable, and consider negative impacts on liquidity and price discovery.
- Liquidity provision by central banks:
  - Intervene to prevent impairment in money, securities, and foreign exchange markets when funding or market liquidity deteriorates substantially.
  - Operations may include short- and long-term repo operations, discount window with longer maturities, foreign exchange swaps, and outright asset purchases; consider expanding eligible collateral and counterparties while minimizing moral hazard.

### How emerging and frontier markets should address external pressures
- Manage exchange rate pressures:
  - Use exchange rate flexibility where feasible.
  - Consider multilateral and bilateral swap lines to alleviate foreign currency funding pressures.
  - For countries with adequate reserves, exchange rate intervention can lean against market illiquidity but should not prevent necessary adjustments.
  - Relaxation of macroprudential buffers (for example, foreign currency reserve requirements) can mitigate foreign-exchange funding pressures.
- Managing capital outflows:
  - Outflow capital flow management measures (CFMs) can be part of a broad policy package but cannot substitute for warranted macroeconomic adjustment.
  - CFMs should consider international obligations, be broad-based and effectively enforced, implemented in a transparent manner, temporary, and lifted once crisis conditions abate.
- Prepare for longer-term external funding disruptions:
  - Sovereign debt managers should prepare contingency plans for limited access to external funding.
  - Reducing rollover risks should take priority over containing costs when there are large downside risks to market access.
  - Use cash buffers, seek bilateral and multilateral assistance, or preemptively and cooperatively seek debt resolution with creditors when necessary.

### International policy coordination and IMF support
- Multilateral cooperation priorities:
  - Avoid price controls and ease trade restrictions on essential medical supplies.
  - Expand bilateral and multilateral swap lines to a broader range of emerging markets.
  - Coordinate to reduce broader capital flow disruptions.
  - Maintain post-global financial crisis regulatory gains; avoid rollbacks or fragmentation.
- IMF resources and actions:
  - IMF with $1 trillion in available resources is actively supporting member countries through various lending facilities.
  - Doubling of access limits of the IMF’s emergency financing facilities will allow the Fund to meet an expected demand of $100 billion in emergency financing, provided through the Rapid Credit Facility and the Rapid Financing Instrument (the former only for low-income countries).
  - Catastrophe Containment and Relief Trust can currently provide about $500 million in debt service relief, including the recent $185 million pledge by the United Kingdom and $100 million provided by Japan.
  - Official bilateral creditors have been called upon to suspend debt repayment from International Development Association countries that request forbearance to help meet immediate liquidity needs.

*Source: Chapter 1, "Chapter 1 at a Glance", Global Financial Stability Report: Markets in the Time of COVID-19 (April 2020).*

### Chapter 1 at a Glance

### Chapter 1 at a Glance

### Key developments
- Global financial conditions have tightened abruptly with the onset of the COVID-19 pandemic.
- Risk asset prices have dropped sharply as investors have rushed for safety and liquidity.
- Emerging and frontier markets have experienced a record portfolio flow reversal.
- 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.
- Banks’ resilience may be tested as economic and financial market stress rise.
- Strong policy response and international cooperation are needed to tackle these challenges.

### Government bond markets and monetary policy
- Market-implied probability of inflation falling below 1 percent in any single year over the next five years spiked in Europe and in the United States on concerns about the economic impact of COVID-19 and the fall in oil prices.
- As central banks responded with decisive monetary policy easing, policy rates in several advanced economies came down close to zero.
- The stock of government bonds with yields of less than 1 percent doubled from about 40 percent of bonds outstanding at the end of 2019 to about 80 percent in March.
- Treasury yields fell sharply, and government bond yields are now expected to stay low for even longer.

### Corporate credit markets and borrower leverage
- Conditions in corporate credit markets deteriorated sharply since late February on rising credit and liquidity risks.
- Investment grade bond spreads widened as investors focused on the large share of BBB credits at risk of downgrades and elevated leverage in this market segment.
- Global risky credit market segments—high-yield bonds, leveraged loans, and private debt—had expanded rapidly after the global financial crisis, reaching $9 trillion globally, while borrowers’ credit quality, underwriting standards, and investor protections weakened.
- High-yield bond spreads widened dramatically, particularly for energy firms and sectors most affected by the pandemic, such as transportation.
- Leveraged loan prices experienced a decline of about half the drop seen during the global financial crisis at the worst point of the March sell-off.
- Rating agencies revised up their speculative-grade default forecasts from benign to recessionary levels; market-implied US high-yield defaults rose to 8–10 percent.
- Global issuance of high-yield bonds came to a halt and issuance of leveraged loans fell considerably.
- Following central bank steps (including extending emergency facilities to corporate debt and to collateralized loan obligation vehicles), spreads began to narrow in some risky credit segments.

### Short-term funding and US dollar funding markets
- The US commercial paper market froze as prime money market funds reduced commercial paper holdings to raise cash and dealer banks faced balance sheet constraints and risk limits, causing commercial paper spreads to widen dramatically.
- Short-term funding markets in Australia, Canada, and the United Kingdom experienced similar pressures.
- Conditions in global US dollar funding markets tightened: the spread between LIBOR and a risk-free rate widened sharply and the cross-currency basis widened for most currencies.
- Initial tightening in funding conditions was more severe in economies with large dollar funding demand but with no swap lines with the US Federal Reserve.
- Several central banks agreed to augment US dollar liquidity through enhancements to existing swap lines or new temporary swap lines; since the end of March, pressures in global US dollar funding markets appeared to have abated somewhat.

### Market liquidity, deleveraging, and dealers’ balance sheets
- Financial deleveraging and strained market liquidity aggravated selling pressures: leveraged investors were forced to close positions to meet margin calls or rebalance portfolios, amplifying asset price declines.
- Volatility-targeting investors and those running basis trades in US Treasuries were forced to unwind positions, increasing dealers’ holdings of Treasury bonds and straining dealers’ ability to intermediate markets.
- The two-fold increase in the balances of central counterparty clearing houses with the US Federal Reserve in only two weeks is evidence that leveraged investors faced significant margin calls.
- Liquidity conditions in the US Treasury market deteriorated sharply; high-frequency jump analysis indicates liquidity conditions worsened meaningfully since end-February.
- In response, the US Federal Reserve increased the scale of asset purchases, introduced additional large open-market operations, allowed foreign central banks to repo their Treasury holdings in exchange for dollars, and temporarily excluded US Treasury securities and reserves from the calculation of the supplementary leverage ratio for bank holding companies.

### Stretched asset valuations and equity market dynamics
- Prior to the COVID-19 sell-off, price-earnings ratios in equity markets had reached the highest levels since the global financial crisis; equity valuations had become increasingly stretched since the October 2019 GFSR.
- After the COVID-19 outbreak, equity prices fell sharply through mid-March, wiping out a significant portion of overvaluation in many markets and sectors.
- The US equity market was a notable exception: the decline in prices in March was outpaced by a sharp deterioration in fundamentals-based value, increasing the extent of positive misalignment.
- Dispersion in earnings forecasts spiked to historically high levels—about two times the level seen in the global financial crisis—contributing to a large reduction in fundamentals-based value.
- Downward revisions in earnings-per-share (EPS) growth forecasts have been material in many markets, but as of early April likely do not fully reflect the expected deterioration of corporate earnings outlook.

### Policy response and remaining vulnerabilities
- Several central banks rolled out new facilities and expanded existing programs to support issuance and liquidity in corporate debt and commercial paper markets; these actions helped to reverse some initial widening of investment-grade bond spreads.
- Central banks launched several emergency facilities that provided relief to short-term funding markets.
- US Federal Reserve actions aimed at preventing market disruptions, improving liquidity, and mitigating upward pressure on Treasury yields were implemented.
- Despite policy actions and signs of improved liquidity in recent weeks, vulnerabilities remain: stressed asset managers, leveraged firms, fragile dealer balance sheets, and incomplete earnings revisions could cause further tightening in financial conditions and test banks’ resilience.

*Source: Chapter 1, "Chapter 1 at a Glance", Global Financial Stability Report: Markets in the Time of COVID-19 (April 2020).*

### 2020. In fact, the extent of spread misalignment—the

### ch1 - 2020. In fact, the extent of spread misalignment—the

### Market liquidity: conditions and drivers
- Treasury market liquidity has been impaired, partly due to constrained dealer balance sheets.
- Liquidity conditions have deteriorated across a broad range of markets.
- Bloomberg liquidity index proxy used for aggregate on- and off-the-run spreads (root mean squared error between bonds’ market yields and theoretical yields).
- CTD = cheapest to deliver: economically least valuable cash Treasury security, which a seller of futures contract can deliver to a buyer at settlement.

### Asset valuations: wild swings and earnings revisions
- Extent of spread misalignment (difference between market- and fundamentals-based spreads) had increased in the United States and in the euro area, and remained high in the emerging markets high-yield segment in the last quarter of 2019.
- Spreads were tightening well below levels justified by fundamentals (percentiles at the lowest end of the ranges).
- After the COVID-19 outbreak, most spreads widened dramatically, wiping out prior overvaluations.
- Estimates of S&P 500 EPS growth in 2020 by analysts at major investment banks range from −8 percent to −33 percent.

### Emerging and frontier markets: the perfect storm
- 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.
- Emerging market equity prices have fallen by about 20 percent, on net, since mid-January (despite the most recent rebound).
- Currencies of commodity-producing economies (Brazil, Colombia, Mexico, Russia, and South Africa) tumbled by more than 20 percent against the US dollar in the first quarter of 2020.
- Spreads of dollar-denominated emerging market sovereign bonds rose to nearly 700 basis points by the end of March—the highest level since the global financial crisis—although they narrowed somewhat in recent weeks.
- The number of distressed sovereign issuers (those with spreads over 1,000 basis points) rose to record levels.
- Oil-importing economies have generally fared better, but lower remittances, reduced external funding availability, and lower external demand may outweigh the positive impact of lower oil prices.

### Portfolio flows to emerging markets: a sharp reversal
- Nonresident portfolio outflows from emerging markets reached a record level in dollar terms (more than $100 billion since January 21) and the highest ever relative to their aggregate GDP in the first quarter of 2020.
- Initial outflows were especially strong from Asia and from equity markets; outflows from bond markets became significant more recently.
- The breadth of outflows—in terms of number of affected countries—was the largest since the global financial crisis.
- South Africa and Thailand witnessed outflows of more than 1   percent of GDP in just two months.
- Retail outflows surged, while institutional investors also reduced positions because of redemptions or risk limits.
- Bond portfolio fund flow reversal was broad-based, relatively worse for hard currency bond funds.
- Authorities responded with currency interventions, liquidity support to bond markets and the banking system, and efforts to establish swap lines with the US Federal Reserve and the European Central Bank.

### Global financial conditions and near-term risks
- Global financial conditions had been easing through 2019 and early 2020 but tightened sharply in March 2020; the 2020:Q1 FCI values are based on the March 2020 average.
- Tightening was pronounced and unprecedented in speed, even compared to the global financial crisis.
- Tightening was driven largely by a very significant deterioration in corporate valuations, with falling equity prices and widening corporate spreads only marginally offset by declines in interest rates across most advanced and emerging market economies.
- China’s financial conditions remained broadly stable relative to others, reflecting limited external financial linkages, a strong role of government-owned financial institutions and firms, and early proactive policy actions.
- The 2020 global growth forecast was revised from 3.3 percent (January 2020 WEO Update) to −3   percent (April 2020 WEO), shifting the near-term distribution of global growth sharply to the left.
- One-year-ahead forecast distribution as of March 2020 indicates a 5 percent probability that global growth could fall below −7.4 percent (an event that happens once every 20 years).
- The odds of global growth exceeding zero in 2020 are close to only 4 percent.
- Near-term growth-at-risk metric is approaching levels last seen during the global financial crisis.
- Scenario risk: in the most severe WEO scenario (longer-than-expected containment in 2020 and a second outbreak in 2021), global output would continue to fall throughout 2020 and 2021 and would be almost 8 percent below baseline in 2021.
- A further tightening of financial conditions could limit policy space, weaken investor sentiment, and make it challenging for emerging and frontier markets to contain destabilizing effects of portfolio flow reversals; widespread distress in banks and other financial institutions could cause permanent scarring of balance sheets and delay recovery.

### Financial vulnerabilities in banks and other financial institutions
- Banks entered the period with more capital and liquidity than before and stronger supervisory scrutiny and stress tests, but resilience may be tested by a sharp, protracted slowdown that could generate larger-than-anticipated losses.
- Prolonged dislocation in financial markets may result in distress among other financial institutions, including asset managers, potentially leading to a credit crunch for nonfinancial borrowers.
- Financial vulnerabilities had been elevated in some systemically important economies before COVID-19 (assessment based on April 2019 GFSR methodology covering 29 jurisdictions).
- Vulnerabilities highlighted:
  - Nonfinancial corporate sector vulnerabilities are significantly higher now than in 2008–09, reflecting high levels of debt; a prolonged period of negative growth and elevated funding costs could expose these vulnerabilities.

*International Monetary Fund | Chapter 1, April 2020*

### CHAPTER 1 GLOBAL FINANCIAL STABILITY OVERVIEw: MARkETS IN ThE TIME OF COVID-19

CHAPTER 1 GLOBAL FINANCIAL STABILITY OVERVIEw: MARkETS IN ThE TIME OF COVID-19

### Preexisting Vulnerabilities: sectors and regions
- Vulnerabilities are elevated in the corporate and sovereign sectors as global nonfinancial sector debt has reached new highs.
- Asset managers entered the COVID-19 crisis with higher leverage, maturity, and liquidity mismatches in several countries (notably, China and the United States).
- In the euro area and other advanced economies, vulnerabilities among asset managers are somewhat lower, on aggregate, than in other regions.
- Bank vulnerabilities are moderate overall, though vulnerabilities continue to be high in China and have increased in other emerging market economies and the euro area.
- Insurance-sector vulnerabilities are less pronounced in aggregate than in other sectors but remain high in some countries and regions:
  - In the United States, insurers face elevated liquidity mismatches and credit risk.
  - In other advanced economies, insurers tend to have currency mismatches.
  - In the euro area, credit risks are elevated and coupled with profitability and solvency challenges from the low-yield environment.
  - Chinese insurers operate with high liquidity mismatches.

### Asset managers — losses, redemptions, and potential for fire sales
- Investment funds have faced large portfolio losses since the virus outbreak (Figure 1.11).
- Cash buffers are estimated at about 7 percent of assets for an average open-end fixed income fund.
- Outflows could exhaust cash buffers and force the sale of high-quality liquid assets or less-liquid assets, reinforcing price declines across markets.
- Fixed income funds—especially those exposed to risky credit market segments—faced rapidly growing outflows.
- Mitigating factors include liquidity management mechanisms used by investment funds (including the tapping of credit lines), central bank purchases of corporate bonds, and liquidity facilities offering relief for money market funds.
- Early de-risking by funds (selling less liquid and lower-rated credit assets) may have initially exacerbated price declines in riskier markets.
- So far, there have been very few suspensions of investor redemptions; in the United Kingdom several property funds were gated, and some smaller European bond funds were reportedly suspended with most suspensions lifted within days.

### Banks — resilience, liquidity, and potential amplifying role
- Average Tier 1 capital ratios across economies with large financial systems are more than 400 basis points higher than they were at the end of 2007.
- Total undrawn lines of credit amounted to $10 trillion at the end of 2019 for a sample of almost 400 banks headquartered in Group of Seven (G7) economies—some 50 percent of risk-weighted assets.
- Banks are holding more liquid assets than in the past and have benefited from substantial and coordinated central bank action to provide liquidity, including repo operations and dollars via central bank swap lines.
- Expected bank losses and channels:
  - Declines in asset prices are expected to lead to losses on banks’ portfolios of risky securities, partly offset by gains on safe-haven assets.
  - US commercial mortgage-backed security spreads widened by about 400 basis points, on average, from mid-February to their peak.
  - The longer the sudden stop in economic activity continues, the more likely banks will see credit losses on lending to households and companies.
  - Banks account for about 50 percent to 70 percent of lending to commercial real estate.
  - The fall in the oil price has put energy companies under additional pressure, potentially generating loan losses.
  - Banks may face losses on indirect exposures through lending to households employed in vulnerable sectors.
- Low bank profitability in some advanced economies means banks will have less income to offset losses than in the past.
- The WEO baseline shock (difference between April 2020 baseline and January 2020 WEO Update) is greater over a one-year horizon than the economic shocks typically assumed in FSAP stress tests; the WEO adverse alternative scenario (where the fight against the spread of the virus in 2020 takes roughly 50 percent longer than in the baseline) results in a much larger growth shock than typically assumed in FSAP stress tests in the first year.
- Bank market signals:
  - Bank equity prices fell by about 35 percent, on average, since mid-January and by up to 60 percent in some countries.
  - If market valuations are used to calculate capital ratios, many banks would appear to have weak capitalization—similar to levels during the global financial crisis.
  - Median market-adjusted capitalization is now higher than in 2008 only in the United States.
- Policy implication: decisive policy action is needed to prevent problems at banks leading to a sharp reduction in lending while economic activity is weak.

### Insurance companies — market losses and credit risks
- Shares of insurers in major jurisdictions were hit hard, with most experiencing declines of more than 30 percent before partially reversing losses in late March to early April.
- Insurers’ credit default swap spreads widened alongside those of other financial institutions.
- Insurers’ portfolios are heavily skewed toward long-term sovereign and corporate bonds; heavy losses on fixed income investments weighed on portfolio returns through mid‑March.
- The situation improved for US insurers once the US Federal Reserve stepped in to support the corporate bond markets in late March to early April.
- US insurers are estimated to have over $40 billion of BBB credits at risk of downgrade to sub-investment grade.
  - This $40 billion is less than 2 percent of their corporate bond investments.
- Further increases in corporate bond downgrades could increase losses and capital pressures for insurers.

*International Monetary Fund, April 2020*

### 1. Insurance Sector Equity Prices

### 1. Insurance Sector Equity Prices

### Equity-price impact on insurers
- The shares of global insurers "have been hit hard" with insurance investment portfolios "suffering large losses across fixed income and equity exposures."
- Figure labeling: Index: Jan. 1, 2020 = 100.
- Derivative exposures "could also come under pressure and subject insurers to further losses." Example noted: large life insurers can hold derivatives to hedge guarantees provided by variable annuity businesses.

### Estimated profit and loss of insurance portfolios (illustrative)
- The estimated year-to-date performance of US and euro area insurance portfolios in panel 2 is an illustration of gross portfolio returns and "does not reflect accurately the performance of the portfolios of each insurance company."
- Estimation method and assumptions:
  - Uses broad aggregate data for exposures of insurance portfolios in both jurisdictions as of the third quarter of 2019.
  - Excludes all non-fixed income and equity investments for simplification.
  - Assumes all euro area insurers are invested in the broad Bloomberg Barclays indices for each sector (sovereigns and credit) in the euro area and the Euro Stoxx 50 index.
  - For the United States, Bloomberg Barclays indices and the S&P 500 index are used as proxy.

### Supervisory and policy reactions affecting insurers
- Some supervisors "have already made use of available flexibility in the current framework to mitigate the impact of these shocks on insurers to preserve their operational viability (see 'Policy Priorities' section)."

### Related market-stress context and implications for insurers
- Broader market shocks relevant for insurers:
  - A nearly "60 percent oil price collapse in the first quarter of 2020" increases stress on oil-exporting economies and related exposures.
  - Central banks and authorities implemented wide-ranging measures to stabilize markets that influence insurer balance sheets and funding costs:
    - Central banks cut policy rates by "50–150 basis points in 13 of the 29 jurisdictions with systemically important financial sectors."
    - The US Federal Reserve continues to offer repo operations for at least "$175 billion in overnight repo each day, at least $45 billion in two-week term repo twice per week, and $500 billion in one-month term repo and $500 billion in three-month term repo each week."
    - On March 15, major central banks "started offering US dollars with 84-day terms, in addition to the existing one-week operation."
    - On March 19, the Federal Reserve announced the establishment of temporary US dollar swap lines with nine central banks including four emerging market economies.
  - Central banks expanded asset purchase programs, provided additional liquidity to banking systems, eased collateral terms, and extended the term of operations to put downward pressure on long-term interest rates and mitigate a rise in long-term borrowing costs for households and firms.

### Data and source notes relevant to interpretation
- Sources cited for the insurance panels: Bloomberg Finance L.P.; European Insurance and Occupational Pensions Authority; Haver Analytics; National Association of Insurance Commissioners; and IMF staff calculations.
- Important caveat: the panel 2 estimation is illustrative and uses proxies (Bloomberg Barclays indices, Euro Stoxx 50, S&P 500) and broad aggregate exposure data as of Q3 2019; it excludes non-fixed income and equity investments.

*Source: IMF staff; extracted from "CHAPTER 1 GLOBAL FINANCIAL STABILITY OVERVIEW: MARKETS IN THE TIME OF COVID-19" (April 2020).*

### CHAPTER 1 GLOBAL FINANCIAL STABILITY OVERVIEw: MARkETS IN ThE TIME OF COVID-19

### CHAPTER 1 GLOBAL FINANCIAL STABILITY OVERVIEw: MARkETS IN ThE TIME OF COVID-19

### Central Bank Facilities to Support Funding Markets
- Bank of Canada
  - Bankers’ Acceptance Purchase Facility: Purchases of eligible bankers’ acceptances to maintain credit to small- and medium-sized businesses.
  - Provincial Money Market Purchase Program: Purchases of provincial money market securities in the primary market.
  - Commercial Paper Purchase Program: Purchases of eligible commercial paper in the primary and secondary markets to maintain the smooth flow of credit to corporations.
- Bank of England
  - Asset Purchase Facility: A £200 billion increase in the central bank’s holdings of UK government bonds and sterling nonfinancial investment-grade corporate bonds to a total of £645 billion.
  - COVID-19 Corporate Financing Facility: For 12 months the central bank and Treasury will purchase commercial paper of maturities up to one year issued by companies making a material contribution to the UK economy.
- Bank of Japan
  - Outright purchases of commercial paper and corporate bonds: A temporary (until the end of September 2020) increase in holdings of corporate bonds and commercial paper, moving from reinvesting proceeds of maturing assets into making net purchases.
  - Policy actions to enhance the liquidity and functioning of short-term funding markets: Funds-supplying operations against pooled collateral, purchases of Japanese government securities with repurchase agreements, unscheduled outright purchases of Japanese government bonds, expansion of the Securities Lending Facility.
  - Purchase of Exchange Traded Funds and Real Estate Investment Trusts: A doubling in the pace of exchange-traded fund (ETF) purchases.
- European Central Bank
  - Pandemic Emergency Purchase Program: Purchases of private and public sector securities, until the end of 2020, up to a total amount of EUR 750 billion.
  - Expanded ECB Asset Purchase Program: Additional EUR 120 billion in asset purchases focusing on the corporate sector; collateral eligibility amended to promote inclusion of corporate sector securities.
- US Federal Reserve
  - Primary Dealer Credit Facility: Provision of credit to primary dealers in exchange for a broad range of collateral for term funding with maturities up to 90 days.
  - Commercial Paper Funding Facility: Purchases from eligible issuers, via a Special Purpose Vehicle (SPV), of three-month US dollar–denominated commercial paper.
  - Money Market Mutual Fund Facility: Provision of liquidity to eligible money market mutual funds.
  - Primary Market Corporate Credit Facility: Purchases of investment-grade bonds and some bonds recently downgraded from investment grade from eligible issuers, via an SPV, and loans to eligible borrowers.
  - Secondary Market Corporate Credit Facility: Purchases of investment-grade corporate bonds and some bonds recently downgraded from investment grade in the secondary market from eligible issuers; purchases of investment grade exchange-traded funds (ETFs) along with the remaining funds allocated to high-yield ETF purchases.
  - Term Asset-Backed Securities Loan Facility: Loans to holders of certain AAA-rated asset-backed securities, including collateralized loan obligations and commercial mortgage backed securities, based on newly and recently originated consumer and small business loans.
  - Municipal Liquidity Facility: Purchases of short-term notes issued by US states, counties, and cities.

### Regulatory and Supervisory Measures
- Release of macroprudential buffers and supervisory expectations to use Basel III capital and liquidity buffers (for example, enabling banks to operate below normal liquidity requirements and to use the capital conservation buffers).
- Temporary adjustments to supervisory priorities and easing of certain regulatory requirements, including delaying stress tests, introducing flexibility for banks in their treatment of nonperforming exposures, and easing other requirements.
- Some supervisory authorities recommended restricting bank dividend payouts.
- Insurance supervisors: regulatory actions to support business continuity and fair treatment of policyholders (for example, grace periods on premium payments and more flexibility on supervisory reporting); some National Competent Authorities have gone beyond Solvency II measures; supervisors recommended insurers restrict dividend payments to ensure capital position health.
- Asset manager support: US Securities and Exchange Commission halted enforcement actions against affiliated parties’ purchases of assets from money market funds and temporarily permitted other open-end mutual funds to borrow from affiliated parties and related funds; supervisors in several jurisdictions extended deadlines for regulatory filings.
- Market interventions: Short-sale bans introduced in many countries; circuit breakers triggered and reparametrized in many markets to ensure orderly trading conditions.

### Next Steps, Constraints, and Market Response
- Effectiveness of policies remains difficult to fully assess while events are unfolding; market sentiment showed signs of improvement and risk asset prices retraced through early April some of their earlier declines.
- Continued need for a combination of monetary, fiscal, and financial sector policies to support global financial stability and preserve soundness of financial institutions, especially if economic activity remains paralyzed for longer than expected.
- Key constraints:
  - Policy rates in most advanced economies are now close to or below zero (see Figure 1.17, panel 1).
  - Only about a third of systemically important jurisdictions had the option of releasing the countercyclical capital buffers before the virus outbreak (Figure 1.17, panel 2).
  - Some countries have limited or no fiscal space, making credible fiscal backstops challenging.
- Central bank emergency facilities have been extended to many market segments but gaps remain in reaching the riskiest credit markets; efforts to close these gaps are under way (for example, US Main Street facilities and PPPLF backed by $600 billion from the CARES act with $75 billion in equity from the US Treasury).

### Guiding Principles for Financial Sector Policies
- Loan restructuring
  - Encourage banks to prudently renegotiate loan terms for companies and households struggling to service debts without lowering loan classification and provisioning standards.
  - Banks should assess customers’ creditworthiness on an ongoing basis and update assessments as soon as feasible, taking into account supporting mechanisms provided by governments and guidance by supervisors.
- Accounting treatment of credit losses
  - Regulators clarified how to apply IFRS 9 Expected Credit Loss (ECL) requirements in light of COVID-19: requirements should not be applied mechanically; forward-looking ECL estimates should be reasonable and supportable, reflecting the likely temporary nature of the shock, the impact of economic support measures, and scarcity of reliable information.
- Banks
  - Use existing capital and liquidity buffers to absorb financial costs of loan restructuring and relieve funding and liquidity pressures using full flexibility within existing regulatory frameworks.
  - If impacts are sizable and longer lasting, supervisors should take targeted actions, including asking banks to submit credible capital restoration plans; authorities may need to step in with fiscal support or provide credit guarantees.
  - Emphasize transparent risk disclosure and supervisory expectations; address operational risks and business continuity plans.
- Insurance companies
  - Use the ladder of supervisory intervention permitted in many solvency frameworks to allow flexibility in extreme stress, but supervisors should not signal a lowering of standards.
  - Require insurers to prepare credible plans to maintain or restore solvency while continuing to provide insurance cover; consider macroprudential implications to avoid incentivizing asset fire sales.
- Asset managers
  - Ensure robust application of risk management frameworks and support availability of liquidity management tools (gates/deferred redemptions, swing pricing); encourage full use where in unitholders’ interests.
  - Monitor valuation challenges and provide clarity on expectations, including circumstances for temporary suspension of redemptions.
- Financial markets resilience measures
  - Circuit breakers, volatility controls, and other measures must be well calibrated, clearly defined, and appropriately communicated.
  - Temporary restrictions (including short-selling bans) should consider negative impacts on liquidity and price discovery; restrictions should be temporary and implemented within a predictable framework.
- Liquidity provision by central banks
  - Intervene to prevent impairment in money, securities, and foreign exchange markets when funding or market liquidity deteriorates substantially.
  - Lending operations may include short- and long-term repo operations (reverse repurchase agreements), discount window (possibly at longer maturities), and foreign exchange swaps.
  - Outright asset purchases may be appropriate to improve market liquidity.
  - May need to expand eligible collateral and counterparties beyond normal times while carefully assessing which markets are critical to support to minimize moral hazard and central bank risks.

### How Should Emerging and Frontier Markets Address External Pressures?
- Manage exchange rate pressures
  - Use exchange rate flexibility where feasible.
  - Consider multilateral and bilateral swap lines to alleviate foreign currency funding pressures.
  - For countries with adequate reserves, exchange rate intervention can lean against market illiquidity, but should not prevent necessary adjustments; interventions should be planned on the basis that pressures might last several months or longer.
  - Relaxation of macroprudential buffers (for example, foreign currency reserve requirements) can mitigate foreign-exchange funding pressures.
- Managing capital outflows
  - Outflow capital flow management measures (CFMs) can be part of a broad policy package but cannot substitute for warranted macroeconomic adjustment.
  - CFMs should consider international obligations, be broad-based and effectively enforced, implemented in a transparent manner, temporary, and lifted once crisis conditions abate.
- Prepare for longer-term external funding disruptions
  - Sovereign debt managers should prepare contingency plans for limited access to external funding for a prolonged period.
  - Reducing rollover risks should take priority over containing costs when there are large downside risks to market access.
  - Using cash buffers, seeking bilateral and multilateral assistance, or preemptively and cooperatively seeking debt resolution with creditors may become necessary for countries facing rapidly deteriorating debt dynamics, limited market access, high external financing requirements, or high volatility.

### International Policy Coordination and IMF Support
- Multilateral cooperation priorities:
  - Avoid price controls and ease trade restrictions on essential medical supplies.
  - Expand bilateral and multilateral swap lines to a broader range of emerging markets.
  - Coordinate to reduce broader capital flow disruptions.
  - Maintain post-global financial crisis regulatory gains; avoid rollbacks or fragmentation that undermine international standards.
- IMF resources and actions:
  - IMF with $1 trillion in available resources is actively supporting member countries through various lending facilities.
  - Doubling of access limits of the IMF’s emergency financing facilities will allow the Fund to meet an expected demand of $100 billion in emergency financing, provided through the Rapid Credit Facility and the Rapid Financing Instrument (the former only for low-income countries).
  - Catastrophe Containment and Relief Trust can currently provide about $500 million in debt service relief, including the recent $185 million pledge by the United Kingdom and $100 million provided by Japan.
  - Official bilateral creditors have been called upon to suspend debt repayment from International Development Association countries that request forbearance to help meet immediate liquidity needs.

*Source: CHAPTER 1 GLOBAL FINANCIAL STABILITY OVERVIEw: MARkETS IN ThE TIME OF COVID-19 (PDF).*

### References

### References

### Published references
- Bank for International Settlements (BIS). 2017. “Repo Market Functioning.” CGFS Papers No. 59, Committee on the Global Financial System, Basel.
- Diebold, Francis, and Kamil Yilmaz. 2008. “Measuring Financial Asset Return and Volatility Spillovers, with Application to Global Equity Markets.” The Economic Journal 119 (534): 158–71.
- Keating, Thomas, Francis Martinez, Luke Pettit, Marcelo Rezende, Mary-Frances Styczynski, and Alex Thorp. 2019. “Estimating System Demand for Reserve Balances Using the 2018 Senior Financial Officer Survey.” FEDS Notes, April 9, Board of Governors of the Federal Reserve System, Washington, DC.

### Website References (For Table 1.2)
- Bank of Canada. 2020a. “Bank of Canada Announces New Program to Support Provincial Funding Markets.” https:// www .bankofcanada .ca/ 2020/ 03/ bank -canada -announces -new -program -support -provincial -funding -markets/
- Bank of Canada. 2020b. “Bank of Canada’s Intention to Introduce a Bankers’ Acceptance Purchase Facility.” https:// www .bankofcanada .ca/ 2020/ 03/ bankers -acceptance -purchase -facility/
- Bank of Canada. 2020c. “UPDATED: Bank of Canada to Introduce a Commercial Paper Purchase Program.” https:// www .bankofcanada .ca/ 2020/ 03/ bank -of -canada -to -introduce -a -commercial -paper -purchase -program/
- Bank of England. 2020a. “Asset Purchase Facility (APF): Asset Purchases and TFSME - Market Notice 19 March 2020.” https:// www .bankofengland .co .uk/ markets/ market -notices/ 2020/ apf -asset -purchases -and -tfsme -march -2020
- Bank of England. 2020b. “Covid Corporate Financing Facility (CCFF): Information for Those Seeking to Participate in the Scheme.” https:// www .bankofengland .co .uk/ news/ 2020/ march/ the -covid -corporate -financing -facility
- Bank of Japan. 2020a. “Enhancement of Monetary Easing in Light of the Impact of the Outbreak of the Novel Coronavirus (COVID-19).”  https:// www .boj .or .jp/ en/ announcements/ release _2020/ k200316b .pdf
- Bank of Japan. 2020b. “Market Operations toward the End of March.” https:// www .boj .or .jp/ en/ announcements/ release _2020/ rel200313c .pdf
- Board of Governors of the Federal Reserve System. 2020a. “Commercial Paper Funding Facility.” https:// www .federalreserve .gov/ monetarypolicy/ cpff .htm
- Board of Governors of the Federal Reserve System. 2020b. “Money Market Mutual Fund Liquidity Facility.” https:// www .federalreserve .gov/ monetarypolicy/ mmlf .htm
- Board of Governors of the Federal Reserve System. 2020c. “Primary Dealer Credit Facility.” https:// www .federalreserve .gov/ monetarypolicy/ pdcf .htm
- European Central Bank. 2020. “ECB Announces €750 Billion Pandemic Emergency Purchase Programme (PEPP).” https:// www .ecb .europa .eu/ press/ pr/ date/ 2020/ html/ ecb .pr200318 _1~3949d6f266 .en .html
- US Federal Reserve. 2020a. “Municipal Liquidity Facility.” https:// www .federalreserve .gov/ newsevents/ pressreleases/ files/ monetary20200409a3 .pdf
- US Federal Reserve. 2020b. “Primary Market Corporate Credit Facility.” https:// www .federalreserve .gov/ newsevents/ pressreleases/ files/ monetary20200409a5 .pdf
- US Federal Reserve. 2020c. “Secondary Market Corporate Credit Facility.” https:// www .federalreserve .gov/ newsevents/ pressreleases/ files/ monetary20200409a2 .pdf
- US Federal Reserve. 2020d. “Term Asset-Backed Securities Loan Facility.” https:// www .federalreserve .gov/ newsevents/ pressreleases/ files/ monetary20200409a1 .pdf

*Source: ch1 - References*

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_Source: https://www.imf.org/-/media/files/publications/gfsr/2020/april/english/ch1.pdf_