Speech

Unwinding from the Pandemic

April 6, 2021

Welcome ladies and gentlemen. I am delighted that today we have the opportunity of discussing how we can begin to return to more normalized conditions in the MCD region.

Staff in the Fund are very conscious that our members have had to take a range of responses to the pandemic and we have done our best to offer advice along the way, so that the approaches you have taken best fit your particular circumstances. Today we would like to touch on the more hopeful subject of how to begin to unwind measures that have been taken. Unwinding may not be any easier than taking the measures in the first place, of course, but it means that recovery is on the horizon, and we at the Fund are still your partners along this path.

Knowing when to begin to remove the supporting measures is undoubtedly difficult, but eventually we will need to do so. We cannot prolong our reliance on emergency measures permanently or indefinitely. Were we to do so, we would lay ourselves open to a build-up of macro-financial vulnerabilities. As you know, there is almost nothing the Fund likes less than a build-up of macro-financial vulnerabilities. For example, fiscal support cannot be endless and not only do borrower support measures undermine credit discipline, potentially misallocating scarce resources to non-viable firms, the quality of the assets on the banks’ balance sheets becomes harder and harder to determine with confidence when measures relaxing prudential and accounting standards have been introduced. [One might say the same about central bank ‘support’ in lending to governments; it undermines borrower discipline, and makes it ever harder to determine the quality of the central bank’s balance sheet, and indeed of its policy solvency.] Ultimately the transparency of the banking sector can easily be undermined, and confidence weakened in the financial system particularly when standards have been relaxed. By the same token, unwarranted monetary policy easing may threaten financial stability, and eventually will lead to the de-anchoring of inflations expectations, putting economic growth at risk. These are among the reasons that we need to plan a withdrawal from extraordinary support measures.

And a plan, a strategy to unwind, to withdraw, to remove extraordinary measures, is precisely what is needed. As we went into the crisis, we all wanted and needed to balance economic viability with prudential safety. The strategic objective is very similar now: how to balance economic activity with financial stability.  We entered at a sprint, from a standing start back in February-March last year; now we need to pace ourselves for a marathon, allowing for uncertain terrain ahead but knowing that we cannot run forever.

Each country will need to devise its own plan, its own strategy. Local conditions and circumstances are particular. They were specific before the pandemic and differences may be even more entrenched now. There are, however two principles that I believe need to underpin every strategy that is developed and executed: data and communication. We need data to help inform us of our best options and how quickly we can take them. And we need superb communication to keep our partners and our communities informed of what we are doing. For some member countries your financial sectors will have important cross border links and I urge you to include your peer authorities in your communications. When you have made the decisions related to the preparation and implementation of unwinding policies, authorities should communicate with “one voice” and provide clear timelines for which measures will apply and be unwound. This is not the moment to surprise the market or the consumer.

Banks and financial stability

In creating the strategy and the local sequencing to unwind financial stability support, two factors will weigh heavily in the planning: the condition of borrowers who are or were the subject of support measures, and the condition of the banks (or other systemically important lenders) that have been extending credit and may have been the vehicle for support measures, or may also have been subject to extraordinary measures.

For the best tailored strategies, the best quality data is needed and therefore the supervisors should be increasing their supervisory intensity if they have not already done so. Many supervisors have re-prioritized their work plans since the crisis, and some have done so on a continuous and flexible basis ever since the crisis has developed. This is good practice.  Supervisors should be pressing banks hard in order to make sure the banks understand the condition of their borrowers and quality of the assets on their balance sheets. If the banks and supervisors are not already collecting information on interest income that has been accrued but not received, now is the time to start. This is the first step to exploring whether, and to what extent, there may be an increase in non-performing assets. Supervisors need to be working closely with banks to ensure that banks will be able to work with an increase of distressed assets if this emerges in the wake of the pandemic.

Condition of borrowers

Enhanced data allows the banks to triage its borrowers into viable, viable with restructuring, and non-viable. This data can also inform authorities’ decisions on necessary tailoring of extended support mechanisms, subject to fiscal constraints.

This is not just data that banks should be using to make their commercial decisions on. The supervisors should be monitoring the data closely and requiring additional information as necessary. The supervisor plays a role in challenging banks to ensure that resources flow to the viable firms and companies in the triage process. Similarly, the supervisor should be interested in the restructuring process. Good quality, tailored, loan by loan restructuring is essential. By contrast, blanket restructuring is evergreening and will lead to long-term stagnation and zombie companies.

Condition of banks

The condition of the borrowers, of course, affects the condition of the banks. If asset classifications and provisioning rules were modified as part of the Covid measures, we strongly recommend restoring them as soon as possible to ensure accurate, transparent reporting of asset quality and bank capital. Some jurisdictions have created a dual system of supervisory reporting – one that records loan impairment in real time as well as the one that reflects the effect of any moratorium or relief measure that is in place. This helps banks to detect early signs of distress in their borrowers and, as importantly, it helps supervisors to detect weak banks sooner.

An important task for the banks and the supervisors is to assess, to the extent possible, how much of the portfolios affected by the pandemic will become distressed and ultimately non-performing.  This clearly requires an element of judgment, and the banks’ understanding of each borrower, and is one of the many reasons that supervisors must ensure that banks are closely monitoring the condition of their borrowers. The banks and the authorities should be assessing the impact of high NPLs on bank’s balance sheets and require banks with high NPLs to develop their NPL management capabilities, plans, and tools. Both banks and authorities should run scenario analyses through stress testing to estimate the potential levels of NPLs and consider whether contingency planning for systemic levels of distressed assets are needed.

When capital levels in banks have been eroded, they need to be repaired. If minimum requirements have been breached the authorities must press the banks for their plans for a timely restoration to a minimum level.  Where banks’ buffers have been depleted, a measured approach can be taken, allowing a steady restoration of buffers over time.  Supervisors should consider restricting dividend distribution or extending restrictions as part of a strategy to support the rebuilding of buffers as needed.  

More generally, rebuilding macroprudential buffers such as the CCyB should only be prioritized once the impact of the COVID-19 shock on banks becomes clearer and the economic recovery is firmly underway. A return to a steady-state level should be gradual to avoid procyclical effects and downward pressures on lending, and provide banks with sufficient time to build up the CCyB from retained earnings to the extent possible.

In some instances, however, banks will be badly impaired by the pandemic and ultimately recovery or resolution actions will have to be taken. Authorities are well advised to make sure that all the planning and administrative processes are in place and are up to date. If it is possible to enhance insolvency frameworks or distressed asset markets, then it would be a timely action.

We advise against initiating bank resolutions while pandemic restrictions – in particular the difficulties in on-site visits - apply given the high uncertainty; but there is much constructive action that can be taken. Authorities can review the financial safety net and take prioritized action to strengthen elements that fall below international good practice; the supervisors should continue to apply corrective action frameworks, prepare bank resolution plans, maintain up-to-date contingency plans aimed at responding to potential systemic financial crises; and be ready to intervene if significant problems emerge after removal of exceptional policy support. As I indicated earlier in my remarks – communication and coordination between authorities will be essential for this preparation not only to be undertaken, but also to be effective.

Monetary policy

Data and communication also play key roles in shaping monetary policy. Central banks have supported the economy by lowering policy rates and ensuring provision of sufficient liquidity to the banking system. Most MCD central banks, independently from their monetary policy frameworks, have taken measures to ease stress in short-term funding markets, though intervention in securities markets has been limited to one central bank in the region (Egypt). A number of central banks also intervened to ease stress in the foreign exchange market and to provide FX funding (Morocco). To facilitate provision of liquidity to banks, some MCD central banks broadened their collateral framework – for instance by expanding collateral eligibility to new asset classes (e.g. credit claims in Morocco), and by decreasing haircuts within their risk tolerance (e.g. on government debt securities in Algeria). Whether and when those adjustments to collateral framework should be unwound should reflect the assessment of risks to the central bank’s balance sheet.

We recognize that the availability of fiscal policy space, and judgments about debt sustainability, also impact the central bank’s policy determination and its freedom for maneuver. Continuing or curtailing fiscal support to SMEs, for instance, will clearly impact banks and other creditors; more government domestic debt will impact the yield curve, while more FX denominated debt might influence exchange rate expectations and thus indirectly the monetary policy stance. Unfortunately, we don’t have time to delve into all these areas this morning.

So let me conclude with some thoughts on central banks and monetary policy. Monetary policy going forward should evolve in a data-dependent manner, maintaining or providing the stimulus necessary to ensure a sustainable and inclusive economic recovery, while progressively unwinding the extraordinary measures adopted in response to the Covid-19 crisis. Balancing these two needs will be difficult, especially if the risks of an early monetary policy normalization in the U.S.  and of an asynchronous global economic recover intensify. The consequent depreciation pressures, higher commodity prices, and portfolio outflows could pose significant challenges to central banks. Indeed, some emerging markets already face market expectations of a shift toward a monetary policy tightening.

It will be challenging for central banks to properly time and calibrate when and how to tighten without fueling market stress and heightening financial stability risks.

• Developments in FX markets would deserve particular attention. Central banks would have to carefully assess the risks stemming from adverse balance-sheet effects of any depreciation and capital outflows – including those arising from heightened uncertainties - even in countries where the exchange rate typically works as a shock absorber. [MCD countries are 30% fixed – notably the GCC countries; 40% flexible; and 30% managed.]
• Although governments may face significant financing needs in coming years, central banks should refrain from engaging in monetary financing, which would harm their credibility and potentially destabilize inflation expectations, and risk exchange rate instability.
• Most measures aimed at easing liquidity stress will self-liquidate over time. For instance, demand in fixed rate, full allotment liquidity-providing operations should decrease as banks gradually stabilize and grow alternative funding sources. Unwinding of those measures should take account of market resilience, to avoid a reemergence of liquidity stress and market dysfunction.
• To ensure a smooth market response, any actions will therefore have to be accompanied by clear and effective communication, which may benefit from referring to data when motivating central bank decisions. Communication would play an important role in providing appropriate signals and incentives to markets, especially in countries where central banks pursue multiple objectives using multiple tools.

COUNTRY DETAIL: COULD DRAW ON THIS DURING Q&A

Algeria (Stephane Couderc)

The Banque d’Algerie (BdA)has taken measures to accommodate bank liquidity stress: a significant decrease in its reserve requirement ratio (from 10% to 2%), a decrease in haircuts on government debt securities, and the introduction of a one-month refinancing operation.

The BdA seems to be willing to let inflation creep higher despite public criticism and a negative media coverage of higher prices, giving priority to the expansion of credit. Inflation is still below the 4%-5% objective defined by the Council of Currency and Credit (CMC).

While exit considerations do not seem high on the BdA’s agenda for the moment, they seem keen on avoiding an uncontrolled increase in bank excess liquidity. Recent funding to the State (through the purchase of T-bills) has been a factor driving up bank liquidity.

Lebanon (Thierry Bayle)

Today’s urgency is not the extension or unwinding of Covid measures, but the formation of a government and its engagement toward structural reforms.

On the supervisory side, prudential buffers have been released and accommodative policies have been applied to private sector loan portfolios. However, the impact of these measures is insignificant compared to the general forbearance applied to banks, especially in respect of their exposures to sovereign risk (both the State in default and the central bank), and FX risk.

On the monetary side, monetary policy has been increasingly loose over the past year. A significant money expansion (currency in circulation almost tripled) was driven by (i) a monetization of large fiscal deficits by the central bank and (ii) a “poundization” policy whereby depositors have been pushed to withdraw from FX accounts in Lebanese pounds at an overvalued rate for the latter vis-à-vis the black-market. The dollar exchange rate in the black market  is now10 times the official rate; inflation is around 150%.

The main challenge will be to restore a credible monetary and exchange rate system following the expected massive debt and bank restructuring. Staff will advise unification of the official and parallel exchange rates while bringing them in line with the market conditions, with the aim to restoring external viability, rebuilding and protecting reserves. Appropriate system-wide capital controls and a safety net to buffer vulnerable households will also be critical.

Pakistan (Miao Hui)

SBP cut rates from 13.25% to 7% (inflation is around 9%) and provided debt relief scheme (e.g. Loan Extension and Restructuring) to facilitate the borrowers in restructuring and deferment of their loans.

Banks held up well considering the large COVID shocks. NPLs only increased by 1% in 2020 H1, and the loan deferment (7% of total bank loan) and restructuring cases (1.4% of total bank loans) is modest under SBP debt relief scheme as of June 2020, NPLs are unlikely to rise substantially once the COVID policy expires in 2021. Banks benefited from large revaluation gain from government bond holdings and a surge of precautionary savings.

The challenge facing SBP now is on the pace of interest rate normalization as the market currently expects interest rate hikes within three months, while SBP “forward guidance” indicated otherwise. Financial conditions tightened as the yield curve steepened significantly.

[In the MENAP Ministers’ and Governors’ meeting on April 1, Governor Reza said that the fiscal side had been contractionary in Pakistan, despite COVID, because of debt sustainability concerns, so the SBP had to provide economic stimulus by monetary easing.]

Tajikistan (Sergei Dodzin)

The National Bank of Tajikistan (NBT) has responded in 2020 to the Covid -19 crisis with a number of measures, which were broadly in line with IMF recommendations. These measures included: calls on credit institutions a) to develop action plans to counter the shortfall of capital requirements; b)  to create additional provisions against potential losses, and refrain from unnecessary expenses; c) recommendations to temporarily refrain from buying back shares and paying dividends; d) temporarily easing some fines and penalties to legal entities and individuals that have difficulties in loan repayments; e) temporarily reducing fines on financial institutions for shortfall of capital and liquidity requirements.

In 2021 the NBT banking supervision department asked the IMF and World Bank to provide views and advice on Covid-related policies, including what new measures could be introduced. The IMF advice strongly recommended to refrain from paying dividends until uncertainty is reduced. The team recommended the NBT to increase the intensity of supervision. The advice also emphasized a need of effective communications.

Tunisia (Pierre Guerin)

The key questions that the Central Bank of Tunisia faces now are: How to unwind the support to the financial sector? How to best prepare against an increase in NPLs?

There are concerns about central bank independence with the recent monetary financing operation (a “one-off” operation in theory, but given the heavy gross refinancing needs in 2021, pressure to renew this operation may emerge).

There are also concerns about the implications of the increase in public debt for the bank-sovereign nexus, which could reduce liquidity available for private investment, even though there is no evidence of a crowding-out effect so far. The increased cross-exposure between weak SOEs and SOBs also rises risks of an adverse feedback loop between the sovereign and banks.

UAE (Marcello Miccoli)

The UAE has been very successful in securing and delivering vaccines for residents, recording the second highest vaccination rate globally on a per capita basis.

Policies amounting to around 23 percent of GDP helped alleviate the impact of the crisis on hard hit sectors. Nevertheless, domestic activity has slowed with necessary containment measures, adding to the negative effects from oil price declines and OPEC+ production cuts in 2020.  The financial sector has shown resilience, but weakening asset quality could put the sector under stress. Looking ahead, potential “scarring” effects in key sectors (such as tourism, real estate, and hospitality), could slow the pace of recovery.