Drawing lessons from the 2008 financial crisis, public authorities have acted swiftly, deploying a wide array of fiscal, monetary and prudential measures to counter the effects of the economic shock caused by the Covid-19 pandemic and the associated lockdown measures. The shock, which is larger than any of the recessions in the post-Second World War period, is having a simultaneous impact, in France and around the world, on:
In emerging economies, the collapse in external demand, especially for commodity exporters, has been coupled with substantial capital outflows.
The magnitude of the shock triggered a major stockmarket sell-off amid considerable uncertainty about the outlook for growth and profits. The sudden shutdown in activity fuelled high demand for cash, leading businesses to renegotiate higher credit lines, which they then drew on, while some financial intermediaries sold off their most liquid financial assets. Debt issuance conditions on primary markets were under strain for several weeks, but liquidity injections by central banks have since enabled financial markets to function satisfactorily on the whole, despite high volatility and wider credit spreads.
Governments implemented emergency measures aimed primarily at safeguarding corporate cash situations and household income while also facilitating access to bank credit by providing guarantees to maintain production capacity and ensure that the economy can restart quickly once the health crisis is over.
In the euro area, the European Central Bank (ECB) adopted a new public and private securities purchase programme designed to maintain favourable financing conditions throughout the area, which are necessary to meet its inflation target, and ensure the smooth transmission of monetary policy in all euro area countries. The new programme helped to relieve the strain on capital markets, especially the corporate debt market. Meanwhile, liquidity injection programmes and measures to ease the terms under which commercial banks obtain refinancing from the Eurosystem have preserved banks’ capacity to lend to the real economy – a critical factor in the current crisis.
On the prudential front, authorities decided to allow banks to use capital and liquidity buffers to absorb the shock by enhancing their capacity to lend more to the economy: national authorities released countercyclical buffers, while the ECB, acting as the sole supervisor for the banking sector in the euro area, authorised banks to operate temporarily below the minimum capital requirement (pillar 2 recommendations, capital conservation buffer) and to draw on liquid asset reserves to respond swiftly to the real economy’s financing needs. The European banking regulator also adopted transitional measures covering the accounting and prudential treatment of claims restructured via moratoria introduced by banks to temporarily reduce borrowers’ financial charges.
The early part of this crisis has illustrated the resilience of the financial intermediation system in France and Europe, which is the result of reforms introduced on an international basis since 2009 and in Europe in the aftermath of the euro area crisis. As they face up to an economic recession, French banks are in a much more robust financial position, in terms of their capital levels and liquidity position, than they were during the financial crisis of 2008. As a result, they are able to make an effective contribution to the economy's additional financing needs and have extensive capacity to absorb higher risks, especially credit risks.
However, the crisis is exacerbating risks attached to the trend increase in private debt (households and companies) in France as well as specific weaknesses in market financing and asset management.
With their cash positions under severe strain, many companies are being forced to tap additional debt. Measures taken by the French government and other European governments, including state-guaranteed loans, have helped to respond quickly to these financing needs. The scale of this liquidity shock remains uncertain, and how it is dealt with will depend on the pace of the economic recovery. A rise in company debt could undermine the solvency of many businesses. Furthermore, this risk would be increased by a sluggish recovery and credit rating downgrades. A sharp upturn in company failures could in turn lead to more bad debts on bank balance sheets, dampening the credit growth that is needed for the economic recovery.
At this stage, household solvency remains largely intact thanks to public support measures. Yet a significant rise in unemployment could increase the share of loan repayments, notably on property loans, which make up the bulk of debt service payments, resulting in greater credit risk and/or slacker consumption.
At the same time, the size of the automatic budget stabilisers and the implementation of massive public support measures are leading to a surge in government debt throughout the European Union.
Besides the vital emergency measures, preserving the solvency of viable companies is critical to promoting a recovery. More generally, controlling company debt, household debt and the public finances will be key, not just at the macroeconomic level, but also to financial stability.
Liquidity stress on financial markets and rising credit risk have highlighted the tension that exists between certain individually legitimate actions and their collectively sub-optimal consequences: specifically, investment management funds seeking to strengthen their own individual liquidity positions have exacerbated problems at the global level, creating liquidity stress for other stakeholders, including banks and non-financial companies. The need to develop a macroprudential approach for investment funds, which make a substantial contribution to the disintermediated financing provided to the real economy, and the fragility of leveraged finance are two additional priority areas for French authorities.
Further out, the risks associated with failing to take proper account of the major structural shifts currently under way are growing. Massive use of teleworking and remote service provision heralds an acceleration in the digital transformation of the overall economy and especially of the financial sector, which will entail major investments to make business models more profitable. Financial institutions, whether banks or insurers, must also do more to encourage all participants to switch to a low-carbon economy. The European stimulus plan currently under discussion will definitely have a crucial role to play in supporting the energy transition.
In the face of all of these risks, the French authorities responsible for financial stability are ready to act both to limit adverse developments and to mitigate risks in advance.
Updated on: 07/10/2020 12:35