Monetary and Financial Stability During the Coronavirus Outbreak

IMF Blog, March 11, 2020

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The global spread of the coronavirus is described as "a human tragedy unfolding across the world."
Quantifying the economic impact is complex, giving rise to significant uncertainty about the economic outlook and associated downside risks.
"Such an abrupt rise in uncertainty can put both economic growth and financial stability at risk."
The blog is part of a special series on the response to the coronavirus.
Author and date: Tobias Adrian — March 11, 2020

Measures of economic uncertainty such as equity market volatility "increased sharply in countries around the world."
Stock markets in major economies, such as the United States, the Euro area, and Japan, "all fell sharply and witnessed a surge in implied volatility."
Credit spreads have "widened broadly across markets" as investors reallocate from relatively risky to safer assets.
"High-yield and emerging-market bonds are hit particularly hard."
Spreads of emerging- and frontier-market bonds denominated in U.S. dollars "have widened sharply."
Financial conditions "have tightened significantly in recent weeks," increasing funding costs for companies tapping equity and bond markets.
Resulting economic behavior: firms postpone investment decisions and individuals delay consumption.

Rationale: "The sharp tightening in financial conditions, along with expectations of low inflation, means that monetary policy has a role to play at the current juncture."
Central banks can:
- inject liquidity,
- cut interest rates,
- provide emergency liquidity if liquidity pressures threaten market functioning.
Markets have been anticipating "aggressive easing by central banks," reflected in "the sharp fall in sovereign bond yields in many countries around the world."
Emphasis on coordination: "Synchronized actions across countries increase the power of monetary policy. Therefore, global cooperation to synchronize monetary policy must be high on the agenda."
Cross-border liquidity: "Ample liquidity within countries, and across borders, is the prerequisite to the successful reversal of the rapid tightening in financial conditions."
If conditions deteriorate further, policymakers could revert to tools developed during the financial crisis:
- Example: "The Federal Reserve launched the Term Asset-Backed Securities Loan Facility in 2009."
- Example: "The Bank of England and U.K. Treasury introduced the Funding for Lending Scheme, where a funding subsidy was provided to incentivize the expansion of lending to households, small and mid-sized enterprises and non-financial corporates."
- Other authorities have "deployed variants of such lending schemes that aim at lowering the costs of borrowing in certain sectors."

Market signals: banks’ share prices "have fallen sharply," and banks' bond prices "have also come under some pressure."
Balance-sheet resilience: "Banks are generally more resilient than before the 2008 financial crisis, because they have greater capital and liquidity cushions."
Supervisory guidance:
- "Supervisory authorities should... monitor developments at banks very closely."
- Banks could consider "a temporary restructuring of loan terms for the most-affected borrowers," given the temporary nature of the outbreak.
- Supervisors should work closely with banks to ensure such actions are "both transparent and temporary."
- The goal: "to preserve banks’ financial strength and overall transparency across the financial sector."
Nonbank risks:
- Authorities should be "alert to possible financial stability threats from outside the banking system."
- Increased focus on asset managers and exchange-traded funds, where investors might "liquidate risky investments suddenly."
Market functioning and funding strains:
- "Anecdotal evidence suggests that liquidity has been tightening in many markets."
- There are "strains in U.S. dollar funding markets, where non-U.S. banks and corporates borrow in U.S. dollars."
- "Large swings in asset prices can quickly put markets and institutions under pressure."

Act decisively and cooperate at the global level to preserve monetary and financial stability.
Prioritize global cooperation to synchronize monetary policy.
Ensure ample liquidity domestically and across borders; provide emergency liquidity if needed.
Consider targeted lending schemes or funding facilities to lower borrowing costs in affected sectors, drawing on tools used in 2009 and other post-2008 innovations.
Monitor banks closely and facilitate transparent, temporary loan-term restructuring for most-affected borrowers to preserve bank strength and transparency.
Monitor nonbank sectors, including asset managers and exchange-traded funds, for abrupt liquidations and liquidity tightening.
The IMF will act as needed to help its members face this extraordinary, but hopefully temporary, crisis.

Tobias Adrian — March 11, 2020