Handle with Care: Regulatory Easing in Times of COVID-19

IMF Working Papers, February 26, 2021

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Title: Handle with Care: Regulatory Easing in Times of COVID-19
Authors: Fabian Valencia, Richard Varghese, Weijia Yao, Juan Yepez
Date: February 26, 2021
Core objective: Examine how stock prices reacted to regulatory easing announcements during the COVID-19 shock to assess effects on financial conditions and the flow of credit.

Empirical approach: Intraday event study.
Sample: 18 advanced economies and 8 emerging markets.
Key variable of interest: Stock prices as a driver of financial conditions.
Focus: Regulatory easing announcements across jurisdictions and across regulatory tools (capital regulation, liquidity regulation), and comparison with non-regulatory financial measures.

Overall effect:
- Regulatory easing announcements contributed to looser financial conditions.
- Effects varied across sectors and tools.
Sectoral effects:
- Financial regulatory easing led to lower valuations for financial sector stocks.
- Financial regulatory easing led to higher valuations for non-financial sector stocks, particularly for industries that are more dependent on bank financing.
Tool-specific effects:
- Announcements related to easier bank capital regulation: valuations declined and financial conditions tightened.
- Announcements related to liquidity regulation easing: equity valuation rose and financial conditions loosened.
Other measures:
- Effects from non-regulatory financial measures appear to be generally more muted.

Differentiated impact: Regulatory easing is not uniform—capital and liquidity measures can have opposite effects on equity valuations and overall financial conditions.
Trade-offs for policymakers:
- Easing capital regulation may tighten financial conditions via lower financial-sector valuations.
- Easing liquidity regulation may loosen financial conditions and raise equity valuations.
Consideration for credit flow objectives:
- Regulatory easing can facilitate the flow of credit, but tool selection matters for sectoral valuations and overall financial stability.