Taking stock of the financial sector policy response to COVID-19 around the world

The massive macro-financial shock caused by the COVID-19 pandemic has precipitated an unprecedented global recession and put the financial sector under strain. Aiming to mitigate the impact, financial sector authorities around the world have reacted by implementing a wide-ranging set of support measures to preserve the well-functioning of core markets and maintain the provision of critical financial services to the real economy, including lending and payments, while at the same time safeguarding bank balance sheet transparency and financial stability (e.g. Altavilla et al. 2020, FSB 2020).

Tracking interventions is key to benchmark policy responses across countries, evaluate their effectiveness and potential unintended consequences, and inform policy making going forward. To this end, The World Bank has compiled a publicly available database with financial sector policy measures (Alonso Gispert et al. 2020). The database offers three distinctive features. First, it tracks the measures in over 150 economies with a main focus on emerging market and developing economies (EMDEs). Second, it categorizes the measures using a simple classification to facilitate analysis. Third, where available, each measure is accompanied by a date, the identification of the issuing authority, and a link to the official source of the announcement.

In a recent paper (Feyen et al. 2020), we introduce this database, identify broad patterns of measures taken around the world, and take a first step towards analyzing the determinants of policymakers' responsiveness and activity. The paper illustrates four main types of policy measures. 

• The first category (Banking Sector) mainly comprises measures to facilitate the flow of credit to the real sector through regulatory relief (e.g. encourage the use of capital and liquidity buffers, flexible treatment of non-performing loans and asset classification) and providing direct support to borrowers (e.g. introducing debt repayment moratoria, facilitating loan restructuring), while ensuring bank balance sheet transparency and soundness (Drehmann et al., 2020). 
• The second category (Liquidity and Funding) covers measures that aim to maintain adequate liquidity and funding conditions for financial intermediaries (e.g. direct liquidity injections, lower reserve requirements, US dollar swap lines between central banks) (Cavallino and De Fiore, 2020 and Lane, 2020). 
• The third category (Payments Systems) captures measures aimed at safeguarding the smooth functioning of payments systems including facilitating digital payments, an area of particular importance in EMDEs. 
• The fourth category (Financial Markets and NBFIs) includes all other measures which mainly focus on ensuring the proper functioning of financial markets (e.g. circuit breakers, bans on short selling, other measures by market regulators) as well as support and regulatory guidance provided to non-bank financial institutions, including asset managers, insurance companies, and pension funds.

Figure 1 Cumulative number of COVID-19-related financial sector policy measures around the world (up to 30 October 2020) 

Our database suggests over 3,000 policy measures have been taken as of 30 October 2020. We find that all countries covered have issued at least one measure, 95% put in place at least two, and 71% at least three. Globally, most measures fall into the Banking Sector category (54%), followed by Liquidity and Funding (25%). In both categories, almost all countries have taken at least one policy action. Conversely, fewer than 60% of countries have adopted at least one measure in the Payment Systems or Financial markets and NBFIs categories (Figure 1), although there are differences across regions and countries. To compare financial sector policy activity across countries, we calculate the Financial Policy Response Activity Index (FPRAI) – the sum of the number of measures taken by each country across the four categories. While this index is silent on the quality or impact of policies, it provides a simple and transparent proxy of the level of policy activity. For instance, the index shows that the number of policies implemented in Africa is discernibly lower than in other regions (Figure 2). 

Figure 2 Financial Policy Response Activity Index, 30 October 2020

The scale and timing of the policy response have been different depending on country characteristics. For example, in Feyen et al. (2020), we show that EMDEs that are more economically developed, more populous, and have higher private debt levels were typically more likely to implement their first policy measure faster in the Banking Sector and Liquidity and Funding categories. By contrast, fiscal and external factors do not appear to significantly influence policymakers’ timing of the responses. Consistent with these findings, the FPRAI is higher in countries that are richer and more populous. The empirical results suggest that the spread of COVID-19, macro-financial fundamentals, the size of fiscal packages, and lockdown policies did not play a significant role. We also explored the role of banking sector characteristics although the results should be interpreted with more care given the smaller sample size. EMDEs with higher bank capitalization and private credit to GDP levels responded faster in implementing Banking Sector measures. Furthermore, controlling for several banking characteristics, EMDEs that adopted features of the capital standards of Basel III and have higher private credit to GDP levels exhibit a significantly lower FPRAI. These findings call for future work to better understand the country determinants of the policy response.

Financial authorities around the world have loosened monetary policy and provided liquidity support (as noted also in Gelos et al. 2020), eased prudential requirements, and supported borrowers and employees. The policy response in advanced economies (AEs) has had positive spillover effects to EMDEs as they reduced the need for EMDEs to pursue procyclical domestic policies (Aguilar and Cantú 2020). The types of financial sector measures taken in AEs and EMDEs are broadly similar. Nonetheless, the degree of fiscal support is markedly lower in EMDEs (IMF, 2020), and the financial sector policy mix is also somewhat different. For example, compared to AEs, EMDEs have made less use of measures targeting the banking sector, while they have implemented relatively more measures to increase (foreign currency) liquidity and facilitating payments, especially digital payments. Moreover, low- and middle-income EMDEs appear to have relied more heavily on the relaxation of certain prudential regulations that goes beyond the flexibility embedded in the international standards (e.g. lowering minimum risk-adjusted capital requirements, and particular changes in the treatment of non-performing loans), perhaps because they have fewer options at their disposal due to limited policy space, bank-centric financial systems, and less-sophisticated regulatory and supervisory frameworks.

Decisive policy action was necessary to address financial distress in markets and for borrowers, and to support the provision of critical financial services to the real economy. However, for certain temporary measures, authorities should continue to monitor relevant trade-offs between keeping these measures in place to support the real sector and maintain prudent credit risk and liquidity management standards to preserve bank balance sheet transparency and financial stability. In particular, the negative impact of employing regulatory flexibility beyond the international standards, even if temporary, should be carefully weighed against the short-term benefits. This is particularly important for some EMDEs which operate in a more constrained environment and have relaxed certain regulatory requirements that may challenge bank resilience in the medium term. Standard-setting bodies (e.g. BCBS 2020) and the IMF and the World Bank (IMF and World Bank 2020) have issued recommendations that can guide policymakers in this regard. Navigating these trade-offs in EMDEs is also key to preserving hard-won progress made in upgrading their regulatory and supervisory frameworks to align them with international standards.
 

This blog was first published in VoxEU.