Unwinding from the Pandemic
IMF News, April 6, 2021
Source details
- Canonical URL
- Unwinding from the Pandemic
Other formats
Bibliographic details
- Published: April 6, 2021
Overview and strategic objective
- Event: Governors’ Meeting, IMF Middle East and Central Asia Department; April 6, 2021.
- Central question: When and how should central banks and financial sector regulators withdraw interventions and emergency measures introduced in response to the COVID crisis?
- Strategic objective: Balance economic activity with financial stability while transitioning from extraordinary emergency measures to normalized policy settings.
- Two underpinning principles for every national unwinding strategy:
- Data: to inform timing, sequencing, and tailoring of measures.
- Communication: single-voice messaging, clear timelines, coordination with peer authorities and markets to avoid surprises.
Risks of prolonged emergency support
- Prolonged fiscal support and borrower relief risks:
- Undermines credit discipline and misallocates scarce resources to non-viable firms.
- Makes asset quality on banks’ balance sheets harder to determine when prudential and accounting standards are relaxed.
- Central bank support risks:
- Undermines borrower discipline.
- Obscures central bank balance-sheet quality and policy solvency.
- Risks de-anchoring of inflation expectations if monetary easing is unwarranted, threatening economic growth and financial stability.
- Need to plan withdrawal to avoid build-up of macro-financial vulnerabilities.
Banks and financial stability — supervisory priorities
- Two key factors for sequencing unwinding:
- Condition of borrowers subject to support measures.
- Condition of banks and other systemically important lenders that provided or received extraordinary measures.
- Supervisory actions recommended:
- Increase supervisory intensity and reprioritize supervisory workplans.
- Require banks to collect information on interest income accrued but not received.
- Press banks to understand borrower condition and asset quality.
- Monitor and challenge banks’ triage of borrowers into: viable; viable with restructuring; and non-viable.
- Ensure supervisors oversee and challenge restructuring processes; promote loan-by-loan tailored restructurings and avoid blanket evergreening.
- Reporting and transparency:
- Restore modified asset classifications and provisioning rules as soon as possible to ensure accurate, transparent reporting of asset quality and bank capital.
- Consider dual supervisory reporting: (i) loan impairment recorded in real time; (ii) reporting reflecting moratoria/relief measures.
- NPLs and stress testing:
- Assess how much pandemic-affected portfolios will become distressed and ultimately non-performing.
- Require banks with high NPLs to develop NPL management capabilities, plans, and tools.
- Run scenario analyses and stress testing to estimate potential levels of NPLs and contingency planning for systemic distress.
Bank capital, buffers, and resolution
- Capital restoration:
- Where minimum requirements breached, require timely restoration plans.
- Where buffers depleted, allow a measured, steady restoration of buffers over time.
- Consider restricting dividend distributions or extending restrictions to support rebuilding of buffers.
- Macroprudential buffers:
- Rebuilding buffers such as the CCyB should be prioritized only after COVID-19 shock impact becomes clearer and recovery is firmly underway.
- Return to steady-state levels should be gradual to avoid procyclical effects and downward pressures on lending.
- Resolution and contingency planning:
- Avoid initiating bank resolutions while pandemic restrictions (e.g., on-site visit difficulties) apply; focus on preparatory work.
- Strengthen the financial safety net elements falling below international good practice.
- Apply corrective action frameworks, prepare bank resolution plans, and maintain up-to-date contingency plans to respond to potential systemic crises.
- Enhance insolvency frameworks and distressed asset markets where possible.
Monetary policy — timing, calibration, and communication
- Role of data and communication in monetary policy decisions.
- Central bank pandemic responses in MCD region:
- Lowered policy rates and provided liquidity to banking systems.
- Most MCD central banks eased stress in short-term funding markets; intervention in securities markets limited to one central bank (Egypt).
- Some central banks intervened in FX markets and provided FX funding (Morocco).
- Broadened collateral frameworks in some cases (e.g., credit claims in Morocco); decreased haircuts on government debt securities in Algeria.
- Unwinding collateral and liquidity measures:
- Decisions on unwinding collateral-framework adjustments should reflect risks to the central bank’s balance sheet.
- Most liquidity-easing measures expected to self-liquidate over time (e.g., demand in fixed rate, full allotment liquidity-providing operations should decrease as banks stabilize).
- Unwinding should consider market resilience to avoid reemergence of liquidity stress and market dysfunction.
- Interaction with fiscal policy:
- Fiscal space and debt sustainability judgments impact central bank policy freedom.
- Continuing or curtailing fiscal support (e.g., to SMEs) will affect banks and creditors; more domestic government debt affects the yield curve; more FX-denominated debt might influence exchange rate expectations and monetary stance.
- Risks from global developments:
- Early monetary policy normalization in the U.S. and asynchronous global recovery could intensify depreciation pressures, higher commodity prices, and portfolio outflows.
- These pressures could complicate timing and calibration of tightening without provoking market stress and financial stability risks.
- Exchange rate and balance-sheet considerations:
- Central banks must assess risks from depreciation and capital outflows, including adverse balance-sheet effects.
- Exchange rate regimes in MCD: 30% fixed (notably the GCC countries); 40% flexible; and 30% managed.
- Prohibition on monetary financing:
- Central banks should refrain from engaging in monetary financing despite governments’ financing needs, to protect credibility, inflation expectations, and exchange-rate stability.
- Communication:
- Clear and effective communication, supported by data, is essential to provide appropriate signals and incentives when unwinding measures and when central banks pursue multiple objectives with multiple tools.
Country-specific observations and challenges
- Algeria:
- BdA measures: reserve requirement ratio decreased from 10% to 2%; decreased haircuts on government debt securities; one-month refinancing operation introduced.
- Inflation still below the 4%-5% objective defined by the Council of Currency and Credit (CMC).
- BdA prioritizes credit expansion and seems willing to let inflation creep higher; willing to avoid uncontrolled increase in bank excess liquidity. Recent funding to the State (through purchase of T-bills) has driven up bank liquidity.
- Lebanon:
- Immediate priority: formation of a government and engagement toward structural reforms.
- Supervisory prudential buffers released; broad forbearance persists, especially on sovereign and FX exposures.
- Monetary developments: currency in circulation almost tripled; dollar exchange rate in the black market is now 10 times the official rate; inflation is around 150%.
- Recommendations: unify official and parallel exchange rates to market conditions, restore external viability, rebuild and protect reserves, apply appropriate system-wide capital controls, and provide a safety net for vulnerable households.
- Pakistan:
- SBP cut rates from 13.25% to 7%; inflation is around 9%.
- Debt relief schemes provided (Loan Extension and Restructuring); loan deferment = 7% of total bank loans; restructuring cases = 1.4% of total bank loans as of June 2020.
- NPLs increased by 1% in 2020 H1; NPLs unlikely to rise substantially once COVID policy expires in 2021.
- Banks benefited from large revaluation gains on government bond holdings and a surge of precautionary savings.
- Market expects interest rate hikes within three months, while SBP forward guidance indicated otherwise; financial conditions tightened as the yield curve steepened significantly.
- Tajikistan:
- NBT measures in 2020: action plans to counter capital shortfalls; additional provisions against potential losses; refrain from unnecessary expenses; recommendations to refrain from buying back shares and paying dividends; temporary easing of fines/penalties for loan repayment difficulties; temporarily reducing fines on financial institutions for shortfalls of capital and liquidity requirements.
- In 2021, NBT banking supervision asked IMF and World Bank for advice on COVID-related policies; IMF advised refraining from paying dividends until uncertainty is reduced, increasing supervision intensity, and emphasizing effective communications.
- Tunisia:
- Key central bank questions: how to unwind support to the financial sector and prepare for an increase in NPLs.
- Concerns on central bank independence after a monetary financing operation; pressure to renew could emerge given heavy gross refinancing needs in 2021.
- Risks from increased public debt on the bank-sovereign nexus and increased cross-exposure between weak SOEs and SOBs.
- UAE:
- UAE recorded the second highest vaccination rate globally on a per capita basis.
- Policies amounting to around 23 percent of GDP helped alleviate crisis impacts on hard-hit sectors.
- Domestic activity slowed with containment measures and negative effects from oil price declines and OPEC+ production cuts in 2020.
- Financial sector resilient so far, but weakening asset quality and potential scarring in tourism, real estate, and hospitality could slow recovery.
International Monetary Fund